A sponsor has several investors in mind for a new fund: individuals, a family trust and an investment partnership. They may all be able to afford the investment. That does not mean they qualify under the same legal rules.
Choosing between Section 3(c)(1) and Section 3(c)(7) of the U.S. Investment Company Act of 1940 starts with who will own the fund, not simply how much money it plans to raise. As the U.S. Securities and Exchange Commission (SEC) explains, the fund's exclusion, the exemption used to offer its interests and the manager's registration requirements are separate questions. Resolving one does not resolve the others.
3(c)(1) vs 3(c)(7): the main difference
Both provisions let a qualifying fund stay outside the Investment Company Act's definition of an investment company. Lawyers often call them private fund exemptions; more precisely, they are exclusions from that definition. Neither removes the securities laws that govern the offering or the manager.
The basic distinction is between limiting the number of owners and restricting who those owners may be. The statutory exclusions work as follows, subject to the exceptions discussed below:
| Legal question | Section 3(c)(1) | Section 3(c)(7) |
|---|---|---|
| Main restriction | Generally no more than 100 beneficial owners. | Generally limited to qualified purchasers; no equivalent 100-owner cap. |
| Who may invest? | Qualified-purchaser status is not required by this section. Offering and fee rules still apply. | Investors generally must qualify when acquiring their fund interests. Limited exceptions apply. |
| What needs checking? | The owner count, including owners behind an entity where required. | Each investor’s qualifying category and the information supporting it. |
The absence of a 100-owner cap does not mean that 3(c)(7) permits an unlimited investor base without further review. Separate Exchange Act registration tests depend on the fund's assets and holders of record. Those tests are different from the ownership and eligibility rules above.
How do you count investors in a 3(c)(1) fund?
A beneficial owner is the person treated as owning the investment under these rules. Counting signed investor agreements, called subscription agreements, may not tell the whole story when another fund or company invests.
Under Section 3(c)(1), an investing company generally counts as one person. But the fund must look through it to its owners if it holds 10% or more of the fund's outstanding voting securities and is an investment company, or would be one without the 3(c)(1) or 3(c)(7) exclusion.
For example, suppose a fund already has 90 individual owners. An investment partnership with 20 separate owners proposes to acquire 15% of its voting securities. Assuming the look-through rule applies and no other exception does, the count becomes 110, not 91. Calling the partnership a single investor in the paperwork does not change that result.
A special route allows a qualifying venture capital fund up to 250 beneficial owners. It must meet the legal venture capital fund definition and the current $12 million limit on capital already contributed plus capital investors have committed but not yet paid. This is not a general exception for hedge funds, nor a fundraising cap on ordinary 3(c)(1) funds.
Who is a qualified purchaser?
For individuals, the usual qualified-purchaser test requires at least $5 million in investments. That is not a requirement to invest $5 million in this particular fund.
Another category covers a person or entity that owns and invests at least $25 million on a discretionary basis, for its own account or the accounts of other qualified purchasers. Discretionary authority means the power to make investment decisions, rather than simply holding assets for somebody else.
Other categories matter too. Certain family-owned companies can qualify with $5 million in investments. Certain trusts qualify through the status of their decision-maker and each person who contributed assets, provided the trust was not formed specifically to acquire the offered interests. Do not apply the $25 million test to every entity without checking its category.
The definition of investments is narrower than total wealth. It includes qualifying securities, investment property and other specified holdings. For instance, a home used for personal purposes does not count. Debt incurred to acquire investments must be deducted, and special rules affect some business holdings and jointly owned assets.
Suppose someone has $2 million in qualifying investments and a $4 million home. Adding the home does not satisfy the individual's $5 million test. That person may nevertheless qualify as an accredited investor under a different rule.
The fund may rely on a reasonable belief that an investor qualifies. The practical task is to identify the category, obtain information supporting it and resolve inconsistencies. A questionnaire is useful, but an answer that conflicts with other information needs follow-up.
Three investor labels that mean different things
An accredited investor meets a test used in securities offerings. A qualified purchaser meets the separate test generally required for a 3(c)(7) fund. A qualified client meets a test relevant to performance-based compensation, such as a manager receiving a share of investment gains, where the applicable fee rules require it.
For an adviser subject to the federal performance-fee prohibition, Rule 205-3 can permit such fees for qualified clients. With a 3(c)(1) fund, the rule generally looks through the fund to each equity owner charged that fee, subject to its exceptions and transition provisions. An investor may therefore pass the offering test but not the fee test.
Advisory contracts with 3(c)(7) funds have a separate statutory exception from that federal performance-fee prohibition. State law and the agreed fund terms still need review. This is not permission to ignore every rule affecting compensation.
Keep the questions separate in the investor documents. One box marked 'eligible investor' should not obscure which tests were actually checked.
Can the fund’s team invest?
The knowledgeable-employee rule allows qualifying holdings to be left out of the 3(c)(1) owner count and the 3(c)(7) qualified-purchaser test. It covers specified senior roles at the fund or its affiliated investment manager, and certain employees involved in investment activities.
For the investment-employee category, the person must have performed the relevant duties, or substantially similar duties at another company, for at least 12 months. That experience requirement does not apply in the same way to the separate senior-role category.
Working for the firm is not enough. An employee doing only clerical or administrative work does not qualify on that basis, and friends or relatives are not covered merely through their connection to the manager. Record the person's actual responsibilities and the reason the rule applies. Separate offering requirements still need checking.
Can either fund advertise its offering?
Both exclusions require the fund not to make, or presently propose, a public offering. That does not mean every form of public advertising is prohibited.
Under Rule 506(b), the fund cannot use general solicitation: broadly advertising the offering or seeking investors publicly. The rule permits limited non-accredited participation under additional conditions, but the fund's own admission and fee requirements still apply.
Rule 506(c) allows general solicitation if every purchaser is accredited, reasonable steps are taken to verify that status, and the other conditions are met. Federal law says a compliant Rule 506 offering is not treated as a public offering merely because it uses general advertising. A 3(c)(7) fund must still check qualified-purchaser status separately.
Choose the offering route before publishing fundraising material. Form D, state notices and any applicable adviser marketing obligations are separate matters. Filing a notice does not mean that the SEC has approved the fund.
Can a feeder or a second fund solve the problem?
A feeder pools investors' money and invests it in another fund. Each vehicle needs its own legal analysis; the extra entity does not make the underlying investors disappear.
For 3(c)(7), the special-purpose company rule is particularly important. A company relying on the family-company or $25 million category cannot qualify if it was formed specifically to acquire the offered fund interests, unless each beneficial owner is a qualified purchaser. Putting non-qualifying investors into a limited liability company (LLC) is not a shortcut around that restriction.
A sponsor may instead operate separate 3(c)(1) and 3(c)(7) funds alongside one another. Section 3(c)(7)(E) prevents otherwise qualifying funds from being combined for the owner-count and qualified-purchaser tests. It does not establish anyone's eligibility or excuse either fund from meeting its own conditions. Review each entity and its investors before deciding that the structure works.
Changing exclusions and transferring fund interests
Moving from 3(c)(1) to 3(c)(7) requires more than amending a description in the offering documents. Review existing holders, the acquisition-time eligibility requirement, the fund agreement and any required consents. Investors do not receive a general right to remain merely because they joined before the change.
Transfers also need attention. Rule 3c-6 gives special treatment to certain gifts, inheritances and transfers connected with legal separation or divorce. When its conditions are met, it can preserve the original owner's treatment for the 3(c)(1) count or allow the recipient of a 3(c)(7) interest to be treated as a qualified purchaser.
An ordinary sale to another investor is different. So is a restructuring that does not fit the rule. Before approving a transfer, check the recipient, the reason for the transfer and the relevant agreement. The original investor's eligibility is not a blanket answer for every later owner.
What should the documents and compliance file contain?
Start with a written explanation of the chosen exclusion. Keep investor questionnaires, ownership charts and supporting eligibility records together. For a 3(c)(1) fund, maintain an owner count that shows how investing entities and any exceptions have been treated. For a 3(c)(7) fund, record each investor's qualifying category and the basis for accepting it.
The partnership or LLC agreement should support the admission restrictions and transfer controls. Subscription documents should collect the information needed to apply them. A side letter, meaning a separate agreement with one investor, should not promise admission or transfer rights that undermine the fund's exclusion.
The legal checks also need an owner. Decide who reviews new subscriptions, transfers and changes in an investing entity's ownership, and who resolves uncertain answers before an investor is admitted. This work belongs in the subscription package and investor-onboarding process.
For 3(c)(7), qualification generally concerns the time of acquisition. A later fall in portfolio value does not itself require the investor to leave the fund and be repaid. Further acquisitions and transfers need their own review; this is not a daily wealth test.
The broader entity, offering and manager questions are covered in our guide to launching a private fund. Here, the task is to keep the chosen exclusion supported by the fund's actual ownership.
Questions managers often ask
Does a traditional 3(c)(1) fund have a dollar fundraising cap?
Not under that exclusion itself. Its central limit is the number of beneficial owners. The special $12 million capital limit applies to the qualifying venture capital fund route, not to every 3(c)(1) fund. Other legal requirements remain separate.
Must an individual invest $5 million in a 3(c)(7) fund?
No. The usual individual test concerns qualifying investment holdings, not the amount invested in that fund. The fund may set its own minimum subscription in its documents.
Planning a private fund or reviewing its exclusion? Ishimbayev Law Firm's Hedge Fund Formation and Investment Company Act / Advisers Act Analysis services help assess investor eligibility, ownership counting and fund documents before commitments are accepted.
This article provides general information about U.S. private fund exclusions reviewed in October 2026. It is not legal, tax or investment advice.
