November 19, 2010

SEC Proposes Definition of “Venture Capital Fund” for Purposes of Investment Advisers Act Registration Exemption

At an open meeting held earlier today, the Securities and Exchange Commission proposed for public comment rules that would (i) define “venture capital fund” for purposes of an exemption from registration under the Investment Advisers Act  of 1940 (the “Advisers Act”) that will be available to venture capital fund managers (the “VCF Exemption”) and (ii) impose reporting, recordkeeping and compliance obligations upon fund managers that qualify for the VCF Exemption.  This Alert is based solely upon verbal comments made at the open meeting.  We will issue a more detailed, follow-up Alert after the actual text of the proposed rules has been made available.    


Effective July 21, 2011, most private fund managers will be required to comply with substantial disclosure, reporting, recordkeeping, operational and SEC examination obligations as investment advisers who are registered under the Advisers Act.1  However, the Advisers Act includes an exemption from registration for managers that exclusively manage venture capital funds.  Today’s proposed rules address the scope and nature of that exemption.    

Proposed Rules

 At today’s meeting, SEC Commissioners and Staff discussed the following attributes of a venture capital fund for purposes of the VCF Exemption:  

  • The fund’s investments must be exclusively in equity securities of private operating companies as well as cash, certain cash equivalents and, possibly, bridge loans to portfolio companies
  • At least 80% of the fund’s portfolio securities must be purchased directly from portfolio companies rather than on a secondary basis
  • A portfolio company must not borrow in connection with the fund’s investment
  • A portfolio company must use the proceeds of the fund’s investment for operating or expanding the portfolio company’s business
  • The fund’s manager must offer significant managerial assistance to, or control, the fund’s portfolio companies
  • Subject to limitations, the fund may borrow cash exclusively on a short-term basis
  • Interests in the fund may be redeemed only under extraordinary circumstances
  • The fund must hold itself out as a venture capital fund

A limited grandfather rule will be available for existing funds that have held themselves out as venture capital funds.

Commissioners and Staff also discussed reporting, recordkeeping and related compliance obligations of managers that qualify for the VCF Exemption.  As described in that discussion, those obligations would be very substantial, including public disclosures on Form ADV Part 1 and, possibly, periodic examination by the SEC.

What’s Next

Upon publication in the Federal Register, the proposed rules will be subject to a public comment period of 45 days.  Given the controversial and burdensome nature of the proposed rules, we expect that participants in the venture capital industry and other interested parties will submit numerous comments.  In this regard, it is worth noting that several SEC Commissioners voiced concern over elements of the proposed rules at today’s meeting, and affirmatively invited public comments on specific issues, even as the Commission voted to approve proposal of the rules.  SEC Chairman Mary Schapiro affirmed her intention that the proposed rules be finalized well in advance of July 21, 2011 so that fund managers have sufficient time to arrange for their compliance with the Advisers Act, whether or not they qualify for the VCF Exemption.  Nevertheless, we recommend that fund managers promptly begin assessing the steps they will need to take to achieve compliance in order to avoid a difficult situation if adoption of final rules is delayed.

As noted above, we will provide a more detailed Alert after the text of the proposed rules has been released.  In the interim, please feel free to contact your Goodwin Procter LLP attorney with any questions or concerns.

1 Please see Goodwin Procter’s July 23, 2010 Client Alert, “Private Fund Investment Advisers Registration Act of 2010 Signed Into Law.”