SEC Issues Interpretive Guidance on the Venture Capital Fund Adviser Exemption

by Proskauer Rose LLP
Contact

On December 2, 2013, the SEC's Division of Investment Management issued a new "Guidance Update" that provides some important interpretive guidance on the exemption from registration under the Investment Advisers act of 1940 (the "Advisers Act") for certain venture capital fund advisers (the "VC Exemption"). In particular, the Guidance Update clarifies that certain structures and practices common in the venture capital fund industry will not impact the availability of the VC Exemption.

By way of background, the VC Exemption exempts from registration under the Advisers Act investment advisers whose business is limited solely to advising one or more venture capital funds ("VC Advisers"). [1] To qualify as a "venture capital fund" for this purpose, Advisers Act Rule 203(l)-1 provides that a fund must be a private fund[2] that, among other things, holds not more than 20% of its aggregate called capital contributions and uncalled capital commitments (excluding cash and cash equivalents) in non-qualifying investments (the "Qualifying Investment Requirement").[3] A "qualifying investment" is generally defined as an equity security acquired directly from a qualifying portfolio company. A "qualifying portfolio company" is defined generally as a private operating company (i.e., a company that is not itself an investment company or private fund) that is not publicly traded in the U.S or elsewhere (nor a control affiliate of a company that is publicly traded).[4]

The Guidance Update focuses on various scenarios in which compliance with the Qualifying Investment Requirement could be called into question under a literal reading of Rule 203(l)-1. In particular:

  1. Intermediary Holding Companies. Venture capital funds frequently invest in portfolio companies through intermediary holding companies, which do not technically qualify as qualifying portfolio companies because they are not operating companies. Although Rule 203(l)1 expressly permits venture capital funds to ignore wholly owned intermediary holding companies for purposes of complying with the Qualifying Investment Requirement, the Rule does not address situations in which multiple funds invest in a portfolio company through a single intermediary holding company. In the Guidance Update, the Staff states that it will not object if a VC Adviser disregards an intermediary holding company that is wholly owned by multiple venture capital funds for purposes of complying with the VC Exemption, so long as all of the funds are advised by the same VC Adviser (or its related persons).
  2. Feeder Funds. Venture capital funds frequently set up feeder funds to address varying tax, legal or regulatory concerns of their investors. Feeder funds (referred to as "AIVs" in the Guidance Update) invest all of their assets in a master fund, which is not a qualifying portfolio company because it is not an operating company. AIVs do not, therefore, technically comply with the Qualifying Investment Requirement. In the Guidance Update, the Staff states that it would not object to VC Advisers disregarding AIVs for purposes of complying with the VC Exemption, provided that (i) the AIV is formed solely to address investors' tax, legal or regulatory concerns, and (ii) such AIV is not intended to circumvent the VC Exemption's general limitation on investing in other investment vehicles.[5]
  3. Warehousing Transactions. At times, VC Advisers will warehouse investments in qualifying portfolio companies for a venture capital fund that is in the fundraising process by investing in the portfolio company itself and then transferring the investment over to the fund at or shortly after the fund's initial closing. Such a transaction could be considered a nonqualifying investment under the VC Exemption, because the securities in question have not been acquired by the venture capital fund directly from the qualifying portfolio company. In the Guidance Update, the Staff states that it would not object to warehoused investments being treated as qualifying investments for purposes of complying with the VC Exemption, provided that (i) such investment is initially acquired by the VC Adviser (or a person wholly owned and controlled by the VC Adviser) directly from the qualifying portfolio company solely for the purpose of acquiring the investment for a venture capital fund that is actively in the process of raising capital, and (ii) the terms of the warehoused investment are fully disclosed to prospective investors prior to their committing to invest in the fund.[6] The Guidance Update does not, however, specifically address situations where an existing venture capital fund warehouses investments for a successor venture capital fund during the successor fund's fundraising process.
  4. Side Funds. Similarly, the Staff also took the interpretive position in the Guidance Update that it would not object to any transfers between a venture capital fund and any side funds established to invest in parallel with the venture capital fund after the venture capital fund is closed, provided that (i) such transfer takes place within 12 months of the final closing of the venture capital fund, and (ii) the potential for this type of transfer is fully disclosed in the governing documents for both the main fund and the side fund.[7]
  5. Liquidating Trusts. Finally, the Staff took the interpretive position in the Guidance Update that it would not object to the transfer of investments in qualifying portfolio companies from a venture capital fund to a liquidating trust for the purposes of winding up the affairs of the venture capital fund.

*          *          *

A complete copy of the Guidance Update can be found on the SEC's Website at http://www.sec.gov/divisions/investment/guidance/im-guidance-2013-13.pdf. Clients of Proskauer should contact their assigned lawyer to discuss any implications that the new Guidance Update may have on their businesses.


[1] Although exempt from registration under the Advisers Act, investment advisers that rely on the VC Exemption are still required to file annual reports on Form ADV with the SEC as "exempt reporting advisers."

[2] A "private fund" is defined as a fund that relies on the exemptions from the definition of investment company provided in either section 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940.

[3] The other conditions that a "venture capital fund" must meet are:(i) the fund must represent to investors that it pursues a venture capital strategy; (ii) the fund may not offer investors redemption rights (except in extraordinary circumstances); (iii) the fund may not borrow or otherwise incur leverage in excess of 15% of the fund's aggregate called capital contributions and uncalled capital commitments (and then, only on a short-term basis); and (iv) the fund may not be a registered investment company or a business development company under the 1940 Act.

[4] Qualifying portfolio companies also are prohibited from borrowing or issuing debt securities in connection with the venture capital fund's investment in such company and distributing the proceeds of such borrowing or issuance in exchange for the venture capital fund's investment.

[5] Notwithstanding this helpful guidance with respect to feeder funds, the Guidance Update does not address whether other types of alternative investment vehicles (such as alternative investment vehicles formed for tax, legal or regulatory purposes that make one or more nonqualifying investments in lieu of the venture capital fund) would similarly be disregarded.

[6] In a footnote to the Guidance Update, the Staff advised that it would typically expect to see the following items of information disclosed to prospective investors in connection with a fund's contemplated warehousing transactions: (i) the name of the portfolio company; (ii) the cost at which the warehoused investment was acquired; (iii) how the price at which the fund will acquire the warehoused investment will be determined (e.g., fair market value or cost plus interest) and whether such price accounts for any adverse event that may have occurred; and (iv) any potential conflicts of interests arising as a result of the warehoused transaction. The Staff also cautioned VC Advisers to consider their fiduciary obligations under the antifraud provisions of the Advisers Act (including Section 206(3) and Rule 206(4)-8).

[7] As with the Staff's guidance with respect to warehoused transactions, the Staff cautioned VC Advisers to consider their fiduciary obligations under the antifraud provisions of the Advisers Act when engaging in transactions between a venture capital fund and any related side funds.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Proskauer Rose LLP | Attorney Advertising

Written by:

Proskauer Rose LLP
Contact
more
less

Proskauer Rose LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.