Thursday, December 2, 2010

Proposed regulations exempting advisers to “venture capital funds” from the registration requirements

On Friday November 19, 2010, the SEC issued Release No. IA‐ 3111 in which it articulated, among other things, the proposed regulations exempting advisers to “venture capital funds” from the registration requirements of the Investment Advisers Act of 1940. The proposed regulations are mandated by Section 407 of the Dodd‐Frank Wall Street Reform and Consumer Protection Act, and are expected to be codified by new Rule 203(l)‐1 under the Investment Advisers Act of 1940.


The proposed regulations are narrowly tailored to exempt those serving in an adviser capacity to venture capital funds. They do not apply to advisers to other types of private investment funds, such as private equity funds or hedge funds. Key points that are relevant to venture capital fund advisers are as follows:

1. A “venture capital fund” would qualify as such under the exemption only if it meets the following requirements:
* The fund represents itself as a venture capital fund to investors;
* The fund invests in equity securities of private companies in order to provide operating and business expansion capital (i.e., “qualifying portfolio companies,”) and at least 80 percent of each company’s securities owned by the fund were acquired directly from the qualifying portfolio company cash (and cash equivalents) and U.S. Treasuries with a remaining maturity of 60 days or less;
* The fund directly, or through its investment advisers, offers or provides significant managerial assistance to, or controls, the qualifying portfolio company;
* The fund is not registered under the Investment Company Act and has not elected to be treated as a “business development company”;
* The fund does not borrow or otherwise incur leverage (other than limited short‐term borrowing); and
* The fund does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances.
2. The exemption applies without regard to the number of venture capital funds advised by the adviser or the size of such funds.
3. The exemption is not mandatory, thus an adviser may voluntarily register.
4. The SEC has proposed a grandfathering provision for those existing funds that make venture capital investments and hold themselves out as venture capital funds. The provision applies to any venture capital fund that (i) represented to investors and potential investors at the time the fund offered its securities that it is a venture capital fund; (ii) has sold securities to one or more investors prior to December 31, 2010; and (iii) does not sell any securities to, including accepting any additional capital commitments from, any person after July 21, 2011.

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