Qualified Client

A qualified client is an investor that is exempt from the provision of the Investment Advisers Act of 1940. This act prohibits private investment funds from charging performance-based fees. A "qualified client" meets at least one of the following parameters:

• 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 $2.1 million or more, either individually or jointly with a spouse, immediately before entering into an advisory contract, not including the value of their primary residence. This is significantly more than the minimum required for accredited investors. 
• An individual who matches the definition of a qualified purchaser at the time an advisory contract is enacted — including ownership of at least $5 million in investments.
• An individual with the position of executive officer, director, trustee, general partner, a person serving in a similar role, or the advisor.
• An employee of the advisor who is involved in the investment activities, and has been so for at least one year. 

Any investment fund that charges a performance-based fee is restricted to qualified clients. Accredited investors do not meet the qualifications for participating in a fund that charges a performance fee.

A common performance fee structure is 2 and 20. This means a 2% management fee is charged on assets under management (AUM) and a 20% fee on fund appreciation. In this case, the 20% fee is called a performance fee. To legally charge the 20% fee, all clients investing in the fund must be qualified clients. 

Qualified Client Example

An investor with a $2.5 million net worth decides to invest $250,000 into a hedge fund. The fund charges 2 and 20 for its fees, with the latter being a 20% performance fee. The investor meets the minimum $2.1 net worth criteria for a qualified client, allowing the hedge fund manager to charge the investor a performance fee.