Venture Capital Fund Adviser Exemption

Advisers to private funds generally must comply with the Investment Advisers Act (or state equivalent, as applicable) unless an exemption exists. The venture capital fund adviser exemption is appealing to advisers to venture capital funds, in part, because there is no cap on the amount of assets under management they can have while relying on the exemption. Advisers who solely advise “venture capital funds” can rely on this exemption even if they have $150M+ in assets under management, while advisers relying on the private fund adviser exemption are capped out at $150M.

The venture capital fund adviser exemption can really be thought of as a subset within the private fund adviser exemption. Below is a question and answer format looking at the venture capital fund adviser exemption.

Why use the venture capital fund adviser exemption at all?

Advisers could elect to register as an investment adviser. Many venture capital firms want to avoid registration for many reasons (including others):

• They must appoint a Chief Compliance Officer.
• They must file Form ADV, together with the Brochure (Part II).
• Adopting a compliance manual and code of ethics, which requires regular training of staff.
• Updating and maintaining Form ADV
• Obtaining and maintaining securities licenses for principals and registered representatives.
• Complying with advisory contract rules
• There is a prohibition on RIAs charging performance-based compensation (e.g. carried interest) to investors who are not “qualified clients.”
• They must comply with the custody rule.
• They must comply with the advertising rules.
• Additional record-keeping requirements.
• FINRA examinations.
• And more.

What is a venture capital fund?

Immediately below is a brief summary description of the definition of a venture capital fund. Below that is a more thorough definition.

Summary of the definition of a venture capital fund

The fund must represent to investors that it pursues a venture capital strategy. The fund cannot grant investors redemption rights, except in extraordinary cases. After any investment, at least 80% of the fund’s assets must constitute direct equity investments in operating companies. Generally, a secondary purchase of securities in an operating company does not constitute a “direct investment,” and an investment in another fund would not constitute an investment in an “operating company.”

What if the fund acquires common shares from a founder? Does the fund qualify as a “venture capital fund?”

No, unless the investment is less than 20% of the fund’s assets (including uncalled capital).

What if the fund invests into another fund? Does the fund qualify as a “venture capital fund?”

No, unless the investment is less than 20% of the fund’s assets (including uncalled capital).

Statutory Definition of a Venture Capital Fund

Section 203(l) of the Investment Advisers Act of 1940 (Advisers Act) exempts investment advisers that act as an investment adviser solely to 1 or more “venture capital funds.” Rule 203(l)-1 under the Advisers Act generally defines a venture capital fund as any private fund that:

• Represents to investors that it pursues a venture capital strategy;
• Immediately after the acquisition of any asset, other than qualifying investments or short-term holdings, holds no more than 20 percent of the amount of the fund's aggregate capital contributions and uncalled committed capital in assets (other than short-term holdings) that are not qualifying investments, valued at cost or fair value, consistently applied by the fund (20% Basket);
• Does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage, in excess of 15 percent of the private fund's aggregate capital contributions and uncalled committed capital, and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 calendar days, except that any guarantee by the private fund of a qualifying portfolio company's obligations up to the amount of the value of the private fund's investment in the qualifying portfolio company is not subject to the 120 calendar day limit;
• Only issues securities the terms of which do not provide a holder with any right, except in extraordinary circumstances, to withdraw, redeem or require the repurchase of such securities but may entitle holders to receive distributions made to all holders pro rata; and
• Is not registered under section 8 of the Investment Company Act of 1940, and has not elected to be treated as a business development company.

Additional Definitions

Qualifying Investments

• Equity Securities. An equity security issued by a qualifying portfolio company that has been acquired directly by the private fund from the qualifying portfolio company;
• Certain Convertible Securities. Any equity security issued by a qualifying portfolio company in exchange for an equity security issued by the qualifying portfolio company described in paragraph (1) above; or
• Any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary or a predecessor, and is acquired by the private fund in exchange for an equity security.

(iii) Any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary, as defined in section 2(a)(24) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(24)), or a predecessor, and is acquired by the private fund in exchange for an equity security described in paragraph (c)(3)(i) or (c)(3)(ii) of this section.

Qualifying Portfolio Company

• At the time of any investment by the private fund, is not reporting or foreign traded and does not control, is not controlled by or under common control with another company, directly or indirectly, that is reporting or foreign traded;
• Does not borrow or issue debt obligations in connection with the private fund's investment in such company and distribute to the private fund the proceeds of such borrowing or issuance in exchange for the private fund's investment; and
• Is not an investment company, a private fund, an issuer that would be an investment company but for Section 3(a)(7) of the Investment Company Act or a commodity pool.

What are the requirements of an adviser relying on the Venture Capital Fund Adviser Exemption?

Of course all of the fraud provisions under the Investment Advisers Act still apply. However, the other registration requirements are not applicable, including the prohibition on performance-based compensation. Advisers relying on the venture capital fund adviser exemption must file Truncated Form ADV and maintain the filing annually.

What if I have less than $100M in assets under management?

You may be regulated by the State(s) in which you operate or have clients. Find out more about specific state exemptions here: https://blackhill.co/blog/state-exemptions-from-registration-as-an-investment-adviser/

What other exemptions are available?

• Private Fund Adviser Exemption. Solely advises private funds. Caps out at $150M AUM.
• Foreign Private Fund Adviser Exemption.
  • No place of business in the US.
  • Fewer than 15 US investors.
  • Less than $25M in AUM attributable to US investors.
  • Does not hold itself out to the US public as an IA.

As always, get your own legal counsel to evaluate your situation.