The SEC’s Division of Investment Management provided advisers to venture capital funds with guidance on fund structures that do not jeopardize an adviser’s ability to rely on the exemption from registration provided by Section 203(l) of the Investment Advisers Act (the “venture capital exemption”). The guidance provides assurances that the SEC will not object when advisers to venture capital funds use certain common fund structures.
To rely on the venture capital exemption, an investment adviser must, among other things, only advise private funds that meet the Rule 203(l)-1 definition of “venture capital fund.” Advisers relying on this exemption need not register with the SEC, although they must make certain public reports as an “exempt reporting adviser.”
Intermediate holding companies. The SEC staff previously took the position that a venture capital fund could use a wholly owned intermediate holding company formed solely for tax, legal or regulatory reasons to hold its qualifying portfolio companies. The new guidance clarifies that the staff will not object to multiple venture capital funds with the same or related advisers investing in a portfolio company through an intermediate holding company that is collectively wholly owned by the venture capital funds.
Alternative investment vehicles. The staff recognizes that venture capital funds may establish structures to address varying tax or regulatory concerns of investors. For example, an adviser may create a separate alternative investment vehicle (AIV) that elects to be taxed as a corporation and is controlled by the adviser or a related person with the sole purpose of investing in the venture capital fund. Since the AIV invests in the fund and not directly in portfolio companies, however, it may hold more than 20% of the fund’s aggregate capital contributions and uncalled capital commitments in non-qualifying investments. The staff said that it will not object to an adviser disregarding the AIV and relying on the venture capital exemption, provided that the AIV was formed solely to address investors’ tax, legal or regulatory concerns and not to circumvent the requirements of the venture capital exemption.
Warehoused investments. The staff said that it will not object to advisers making “warehoused investments” when they are in active fundraising for a new venture capital fund and subsequently transferring the warehoused investments to the fund. Although the fund will not take ownership from the portfolio company itself, the staff said that a fund can treat such investments as if they were acquired directly from the portfolio company if: (i) each such investment is initially acquired by the adviser directly from the portfolio company and solely for a prospective venture capital fund that is in active fundraising; and (ii) the terms of the warehoused investment are fully disclosed to potential investors in the venture capital fund prior to their investment.
Main funds/side funds. Similarly, the SEC staff will not object to a structure involving a main fund and one or more parallel side funds where an adviser transfers a pro rata share of the main fund’s holdings in portfolio companies to the side funds. The staff said that an adviser can treat such holdings as if they were acquired directly from a portfolio company if such transfer occurs within 12 months of the final closing of the main fund and the potential for this type of transfer is fully disclosed by the main fund and the side funds.
Liquidating trusts. Finally, the staff said it will not object to an adviser using a liquidating trust to wind up the affairs of a venture capital fund, provided that the possibility of the use of a liquidating trust, and the adviser acting as the trustee to such trust, is fully disclosed in the venture capital fund’s documents.
Advisers to venture capital funds should note the importance the staff places on the level of disclosure made to investors and potential investors regarding the use of these structures and the reason for them. Advisers should ensure that the venture capital structures are created to address tax, legal or regulatory issues germane to the fund or its investors, and are not an attempt to circumvent the requirements of the venture capital exemption. That said, advisers relying on the venture capital exemption should take comfort in the staff’s willingness to interpret SEC rules in light of the realities of the private fund and venture capital marketplace.