Wednesday, May 23, 2018

Want to Make Private Market Investments? Make Sure Your TSWF is an Accredited or Qualified Investor!

TSW Community:

If your Tribal Sovereign Wealth Fund (TSWF) has hopes to make private market investments, especially with organized funds, your TSWF will need to be seen as an accredited investor and - in some instances - as a "super-accredited" investor.  In many cases, you will be able to self-certify your TSWF as a qualified investor, but you'll likely need to sign representations you are qualified in the subscription agreement and investor questionnaire. This varies from manager to manager - some will ask, some won't. The bigger and more "institutional quality" the fund, the more likely they'll ask.

If private market investments are part of your strategy (assuming you have a growth objective - as discussed here), I'd suggest making sure you meet these qualifications BEFORE you start looking at opportunities and spending money on diligence / document reviews.

First off, you'll need a legal entity from which to invest. Also, under the current policy, you cannot qualify as a sub-unit of a tribal government as there are no qualified investor definitions for tribes (or any government body, for that matter). To make it simple, legal entity options could include LLCs, C-Corporations or Section 17 Federal Corporations.

A good summary on the various accreditation levels can be found around the web, and I particularly liked the overview presented by the Strictly Business Law Blog here, so I'm going to paraphrase some of it below.

Let's go over a few of the "levels" of accreditation you may be faced with when trying to make a commitment to a private fund (or limited partnership):

Level 1: Accredited Investor

If you're considering an investment in a fund (limited partnership or LLC), the investment will be considered a security by the Securities and Exchange Commission (SEC). In many cases, the fund manager will look to exempt the security from registration (and make his/her life easier) by issuing the security as a "Reg D" offering (Securities Act of 1933, Regulation D, Rule 506(b)).

In order to do this, the fund manager must limit the offering to Accredited Investors. In other words, he/she can't just advertise the investment opportunity to anyone - they must have a minimum level of income or wealth (as a proxy for investment savvy and risk tolerance).

Rule 501 defines who is an accredited investor - including qualifiers for individuals and entities. For purposes of this discussion, we'll focus on the entity qualifier most TSWFs will want to use. Your TSWF will be considered "accredited" if:

  1. it is not formed for the specific purpose of acquiring the interest in the fund (i.e., it has or intends to make other investments) AND 
  2. has total assets in excess of $5M.

So what does this mean? Basically, it means you'll need to contribute at least $5M to your TSWF entity before you're going to be able to qualify for most private market investments, and your commitment to any single investment will need to be less than your total fund size (obviously, because you're diversifying, right?).

Level 2: Qualified Client

Fund managers typically get paid in two ways: (1) management fees and (2) performance fees. The management fee is based on a small percentage (generally 1-3% per year, depending on the fund type) of  your capital commitment or the total invested assets, and typically goes down over the life of the fund once the investments have been made. For example if you commit $100 and the management fee is 2%, then the manager collects $2/year for the management of your assets. The performance fee (normally referred to as carried interest) is manager compensation realized on the profits of the fund, and is based on a percentage (generally 10-30%, depending on the fund type) of capital realization. In other words, if you invest $100 in a fund with a 20% carried interest and the fund value appreciates to $300, then the manager is entitled to 20% x $200 = $40.

In certain cases, particularly if the fund manager is registered with the SEC and/or located in particular states, they aren't allowed to collect performance fees from an investor unless the investor is a Qualified Client. Per the Investment Advisors Act of 1940, Rule 205-3, your TSWF will be considered qualified if you meet any of the following criteria:

  1. it invests more than $1M in the fund OR
  2. it has a net worth of more than $2.1M prior to the investment OR
  3. it meets the criteria of a Qualified Purchaser (see below).

So what does this mean? Basically, your TSFW could be an Accredited Investor but if the manager meets certain criteria, the manager may not want your TSFW as an investor in his/her fund if your TSFW doesn't meet the qualified client criteria. After all, he/she won't be able to get paid on performance, which is often the biggest component of their compensation.

Level 3: Qualified Purchaser

Just like the Securities Act of 1933 allows for a securities registration exemption if all investors are Accredited Investors, the Investment Company Act of 1940 allows for investment company registration exemption if it has less than 100 investors and isn't making a public offering of securities.  Most smaller funds leave it at that.

However, certain funds expect more than 100 investors and/or have legal counsel who are a bit more conservative in nature. Typically, these are funds catering to larger, institutional investors. These funds use a separate section of the Investment Company Act of 1940 to authorize their exemption, but it requires all investors to be Qualified Purchasers. Your TSWF will be considered a qualified purchaser if:
  1. it is not formed for the specific purpose of acquiring the interest in the fund (i.e., it has other investments) AND 
  2. has total assets in excess of $25M.
So what does this mean? Basically, its the same thing as qualifying as an Accredited Investor, but the asset threshold is quite a bit higher - five times higher, to be exact. It also means that if your TSWF is capitalized in phases (like an annual capital contribution), you need to be aware of the timing and the requirements put further by the particular fund in which you'd like to invest. If the fund requires qualified purchasers and your TSWF is sitting at $20M in investable assets, you'll likely be out of luck unless they make an exception (which they may be able to do, by the way). A better approach would be to have this discussion at the outset and start with a $25M initial capital contribution.

Bottom line. If you want access to certain funds, you'll need to start out with a decent amount of investment capital either deposited or committed (w/ a binding contract from the tribe) to the TSWF.

In Perpetuity,


  • I'm not a lawyer and this is not legal advice. If you're considering a private market investment in an unregistered security, I'd suggest you have a qualified attorney take a look at the documents. Need some suggestions, give me a shout.
  • On performance fees like carried interest, I ignored hurdle rates, clawbacks, etc to simply the examples. Talk to someone who knows the various terms before you agree to any fee structure.

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