Venture Capital Advisors Must Now Register with the SEC
Dodd-Frank and Changes to the Private Fund Adviser Exemption
If you are an adviser to a venture capital fund, the SEC recently adopted final rules implementing part of the Dodd-Frank Act that may apply to you.
As a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) signed into law by President Obama on July 21, 2010, the Investment Advisers Act of 1940 (Advisers Act) was amended to eliminate the "private adviser exemption", which had exempted many private equity/venture capital fund advisers from registration under the Advisers Act (so long as the private adviser had less than 15 clients and met certain other conditions).
With the passage of the Dodd-Frank Act, the former broad private adviser exemption was eliminated and replaced with two narrow exemptions. The first of the new exemptions generally exempts private fund advisers with less than $150 million in assets under management in the United States so long as they advise only private funds. The second, the one you need to become familiar with, is directed at advisers to venture capital funds. Advisers qualifying under either exemption are referred to as "exempt reporting advisers."
The New Venture Capital Fund Exemption
On June 22, 2011, the SEC adopted final rules implementing the provisions of the Dodd-Frank Act establishing the new exempt reporting adviser exemptions. Rule 203(l)-1 defines a "venture capital fund" as any private fund that:
- Represents to investors that it pursues a venture capital strategy;
- Holds no more than 20% of the fund's capital commitments in investments that are not "qualifying investments" (discussed below) or short term holdings (including cash and cash equivalents, U.S. Treasuries with a maturity of 60 days or less, and money market funds);
- Does not borrow or otherwise incur leverage in excess of 15% of the fund's aggregate capital contributions and uncommitted capital (and any borrowing or leverage must be for a non-renewable term of no longer than 120 days);
- Does not provide investors any withdrawal, redemption, or other similar liquidity right except in extraordinary circumstances; and
- Is not registered under § 8 of the Investment Company Act.
A "qualifying investment" includes equity securities (including convertible debt) of "qualifying portfolio companies" that are acquired by the fund. A "qualifying portfolio company" is generally any company that:
- is not a reporting company under § 13 or § 15(d) of the Securities Exchange Act of 1934 (i.e., is not a "public company"), and
- is an operating company (and not itself a fund or investment company).
Grandfathered Venture Capital Funds
As a part of the new final rule, the SEC included a grandfathering provision for venture capital funds. Private funds not meeting the requirements above may still qualify as a venture capital fund provided the fund:
- represented to its investors when formed that it would pursue a venture capital strategy;
- sold securities prior to December 31, 2010 to one or more investors that are not related persons of any investment adviser of the fund; and
- does not sell any securities to (including accepting any committed capital from) any person after July 21, 2011.
Reporting Requirements for Exempt Reporting Advisers
Exempt reporting advisers (which includes advisers to venture capital funds that qualify under the grandfathering provision) are required to file a newly revised Form ADV electronically with the Investment Adviser Registration Depository to provide certain disclosures about the adviser (such as basic identifying information; financial industry affiliations; information about control persons, ownership and executive officers; and disciplinary history). Exempt reporting advisers must update their filings:
- if certain information reported becomes inaccurate, and
- in any event, within 90 days of the end of the adviser's fiscal year.
Effectiveness of the Changes
Exempt reporting advisers are required to file a Form ADV no later than March 30, 2012. Advisers in existence on or before July 20, 2011 and previously exempt from registration under the former private adviser exemption, but who do not qualify as exempt reporting advisers, are permitted to delay filing their first Form ADV until March 30, 2012.
What This Means for You
If you are currently in the process of raising capital for or operating a venture capital fund that will not meet the new definition discussed above, then if you want to fall under the grandfathering provision you must stop selling securities and accepting capital commitments on or before July 21, 2011.
If you are an adviser or manager of a venture capital fund, you should start to familiarize yourself with the new obligations imposed on you by the new SEC rules and leave yourself plenty of time to complete your first Form ADV filing.
Any questions regarding the Private Fund Adviser Exemption can be directed to Kris Kemp or Michael Mills.
