Qualified Client Definition

Investing often seems like a complicated industry that can frighten people who don’t have much experience. Before searching for investment opportunities, it’s important to know whether you meet the definition of a qualified investor. If you do, you may have to pay more money for investment services. But you may also get better services that earn you bigger profits.

Definition of a Qualified Investor

The Qualified Client definition comes from Rule 205-3 of the Securities and Exchange Commission’s (SEC) Investment Advisors Act of 1940. This section of the law regulates investment advisory contracts. The definition actually includes several ways for individuals and organizations to become a qualified client. According to the law, people are considered qualified investors when they:

Criteria to be a “qualified client”

To qualify as an accredited investor, an individual needs to have a net worth greater than $1 million, or annual earned income in excess of $200,000 ($300,000 with a spouse) for three years.

A “qualified client” must meet one of the following criteria:

  • An individual with at least $1 million in assets under management with the advisor immediately after entering into an investment advisory contract with the advisor.
  • An individual with a net worth of more than $2.1 million, either by themselves or jointly with a spouse, immediately before entering into an advisory contract, excluding the value of their primary residence.
  • An individual who meets the definition of a “qualified purchaser” at the time an advisory contract is entered into, which requires ownership of at least $5 million of investments.
  • An individual who is an executive officer, director, trustee, general partner, or person serving in a similar capacity, or the advisor.
  • An individual who is an employee of the advisor who participates in the investment activities of the advisor, and has done so for at least 12 months.

Source: https://www.fool.com/investing/2018/02/14/what-is-a-qualified-client.aspx

Various organizations and legal entities can also become qualified investors.

According to the qualified investor definition, suitable entities include:

  • A business exclusively owned by accredited investors
  • A financial institution such as a bank or credit union
  • A registered investment company or business development company (according to the definitions described in the Investment Company Act of 1940)
  • A trust with at least $5 million in assets. The trust, however, cannot be formed specifically to acquire investment interests. It must also be run by someone who has significant financial and investment experience.
  • A 501(c)(3) with at least $5 million in assets
  • An employee benefit plan with at least $5 million in assets (but only when investment decisions are made exclusively by accredited investors)
  • A state employee benefit plan with at least $5 million in assets

Any person or entity that meets at least one of these characteristics is likely a qualified investor.

Defining Characteristics of Qualified Investors

The characteristics that define qualified investor were first established by the Investment Advisors Act of 1940. The law started as the Public Utility Holding Company Act of 1935, but slowly morphed into a conclusion set of rules and definitions over the next five years as members of Congress debated specific portions of the act. Congress passed the act in 1940. Since then, the regulations have been overseen and enforced by the SEC.

Portions of the Investment Advisors Act of 1940 have been altered by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. These reforms, however, largely regulate professionals within the investment and financial advisory industries. They have little effect on defining characteristics or qualified investors.

It’s important to recognize how these acts affect money invested and earned by qualified investors. The most important difference between qualified investors and other investors is how fund managers charge their clients. Registered investment advisors can only charge performance fees to investors who fall within the definition of qualified investors or qualified clients. It’s assumed that people and organizations that have access to significant wealth can afford to pay performance fees while others may not have enough money to afford such a charge. It’s also assumed that fund managers will work harder to increase investment returns for qualified investors. Since the managers want to earn performance fees from their wealthiest clients, they will naturally dedicate more energy into making sure they choose investment opportunities that are likely to flourish.

By rewarding fund managers who meet performance goals, investors often see an increase in profits while the managers also get to make more money. While this often means that qualified investors spend more money on investment services, it also means they get healthier returns on their investments. Ideally, it’s a win-win for everyone in the industry.

The Differences Between Qualified and Accredited Investors

The qualifications for becoming a qualified investor or an accredited investor are almost identical. The biggest difference is that accredited investors get to include their primary residences as assets while qualified investors cannot.

When it comes to investing, qualified investors usually have to pay larger fees based on a fund’s performance. Accredited investors only have to pay fund management fees, which are often as low as 2%. Qualified investors, however, have to pay performance fees that can range between 10 and 40%. The industry standard is around 20%. Even though accredited investors do not pay performance fees, they can usually invest in funds that are open to the public.

Fund managers will have slightly more interest in finding qualified investors instead of accredited investors, but both are valuable to the business. Securing the business of a qualified investor means that the fund manager makes more money. Managers who work with private funds may choose to only accept qualified investors as clients. Acquiring the business of an accredited investor, however, creates the potential for making more money in the future.  Accredited investors are often only a few hundred thousand dollars away from becoming qualified investors. Once their investments cross that line, the fund managers can charge performance fees in addition to management fees.

The downside of being a qualified investor or qualified client is that you have to pay higher fees. The benefit, however, is that managers often devote more time and energy to making sure their qualified clients make as much money as possible. When the qualified client makes more money, the fund manager gets to earn more from higher performance fees. If you’re looking for qualified or accredited investors for your hedge fund or private equity offering, contact us and we will gladly help you build a list of qualified prospects.

For more information please visit our mother site at Salesleads.tv