Navigating the Qualified Purchaser Threshold for Trusts Investing in Private Securities

Companies and individuals are not the only ones that invest in private equity.  

Trusts can also be private equity investors.  

A main tool used by estate planning attorneys to handle the disbursement of property for their clients during their lifetimes and after death, trusts, when properly structured,  can be used to invest in alternative investments — such as private equity. 

Trusts can be structured to be “accredited investors” or “qualified purchasers” for investment purposes. Below, we will look at some of the complexities that navigating the qualified purchaser threshold has for trusts investing in private securities.

But first, let’s get clear about the entities we are talking about: trusts.

What is a trust?

A trust is a legal entity that has distinct rights. It is made up of three parties: 

• the trustor — the person who creates the trust. 

• the trustee — the person or entity who manages the trust property; and 

• the beneficiary — the person for whose benefit the trust was created.

When properly formed, trusts can invest in private equity as “accredited investors” or, as will be discussed more fully below, “qualified purchasers.” 

Let’s see what criteria a trust must meet to be a “qualified purchaser,” and how trusts can navigate the qualified purchaser threshold.

What is a “Qualified purchaser”?

The Investment Company Act of 1940 (“Investment Company Act” or “Company Act”) defines and regulates investment companies. Investment companies that issue securities and have more than 100 investors must register with the Securities and Exchange Commission (SEC) unless the investment company is not going to go public, and it offers securities exclusively to qualified purchasers. 

The Company Act defines a “qualified purchaser” as: 

1. a natural person owning (either singly or held jointly with his spouse) at least $5 million USD of investments,

2. a family company owning at least $5 million USD of investments,

3. a trust (other than a trust falling within the preceding category) not formed for the specific purpose of acquiring securities, of which each of the settlor and any trustee controlling investment decisions is a qualified purchaser, and

4. certain institutional investors, acting for themselves or others, that own and invest at least $25 USD million of investments.

The “qualified purchaser” standard is a higher one than that of an “accredited investor.” 

Under the SEC’s rules, an accredited investor is an individual or entity that meets certain income and wealth metrics. Issuers frequently use a trustworthy accredited investor verification service to meet the SEC’s requirements of verifying accredited investors, to ensure that each investor meets the SEC’s income and wealth requirements. 

Although the definition has changed over time and is still a matter of debate, individuals can qualify as “accredited investors” if:

• the person individually had an income in excess of $200,000 USD or a net worth (excluding his/her primary residence) of over $1 million USD in a two-year period, or

• the person had joint income with a spouse or spousal equivalent in that same timeframe in excess of $300,000 USD, and that level of income is expected to continue.

A qualified purchaser, on the other hand, is not required to establish a specific income amount. Instead, a qualified purchaser must have an investment portfolio of over $5 million USD  if an individual, and over $25 million USD if a group. 

Qualified purchasers have access to more private equity investment opportunities, including funds with more than 100 investors, and 3(c)(7) funds under the Investment Company Act (discussed below), that accredited investors do not have access to.

The “Qualified Purchaser” Exemption

Unless an exemption exists, the Company Act requires investment companies (i.e., entities that issue securities and are primarily engaged in the business of investing in securities) to register with the SEC. 

The Company Act provides two exemptions from the registration requirement. These exemptions are found in Section 3(c)(1) and Section 3(c)(7).

Section 3(c)(1) exempts investment companies that do not intend to conduct a public offering and which are owned by fewer than 100 investors.

Under Section 3(c)(7), investment companies with more than 100 investors that likewise do not intend to make a public offering, and whose securities are owned solely by “qualified purchasers,” do not have to register with the SEC.

How Can a Trust Become a “Qualified Purchaser”?

Trusts that are structured so as to be considered a “qualified purchaser” under Section 3(c)(7) (often referred to as “3C7”) can invest in private offerings. This gives the trust a wider range of investment opportunities, including alternative investments like private equity. 

However, this is an extremely complicated and complex area of law. Navigating the qualified purchaser threshold for trusts investing in private equity should be undertaken only after seeking advice from all proper professionals. Practitioners need to fully understand how to properly structure the trust and any securities transactions the trust may enter into — issues that are beyond the scope of this blog post.

With that said, according to experts, there are generally 3 ways a trust can become a “qualified purchaser”:

1. the trust independently meets the “qualified purchaser” threshold and acts for itself or on behalf of other qualified purchasers, who, in the aggregate, own and invest at least $25 million USD on a discretionary basis,

2. a “family company” trust that holds at least $5 million USD of investments, or 

3. a non-family company trust that was not formed for the specific purpose of investing in a particular fund and where all the trustees or persons granting assets to the trust are qualified purchasers.

If a trust is a “qualified purchaser,” it can acquire private securities and take advantage of exclusive investment opportunities. According to experts, over the next few decades we can expect to see the largest intergenerational transfer of wealth ever to occur. And trusts will be a significant part of this. So being able to negotiate the qualified purchaser threshold for trusts may become even more important in the near future.

Again, this is a very complicated area of law that requires expertise and in-depth knowledge concerning both trusts and securities, so be certain to consult with all professionals for guidance and more detailed information on this subject.

The securities laws touch on a vast number of financial and investment issues of importance to estate planners, investors, and issuers alike. VerifyInvestor.com makes verifying accredited investors easy, cost-effective, secure, and reliable. Our services, (which also include AML/KYC,  qualified purchaser, and qualified client verification), are always code-compliant and confidential. We help companies fully and easily comply with their legal obligations to verify accredited investors.