Do Venture Capital Register With The Sec

Forming a venture capital fund is akin to creating, running and financing a startup, but with a higher degree of difficulty as a result of the overlay of several country and federal laws. Additionally, a number of legal disciplines, such as securities, employment, revenue enhancement and corporate laws, that are implicated in the formation of the fund complicate matters more than.

This article provides a primer on these topics, which will hopefully pb to a benign discussion with legal counsel prior to the germination of your fund.

Fund Structure

Most venture capital funds are structured every bit limited partnerships, with the full general partner serving as the fund manager (which itself is typically organized as a limited liability company) and interim as the investment adviser to the portfolio companies of the fund (which are unremarkably incorporated equally C-corporations). The general partner is an entity through which the fund managers brand management, disposition and other decisions related to the fund'south investments and business diplomacy, and the limited partners are passive investors, such every bit pension funds, foundations, insurance companies and high net worth individuals.

Alternatively, venture uppercase funds can be organized every bit limited liability companies and managed by a separate entity, which is usually another limited liability company.

In either fund structure, the funds must be organized under country law (Delaware is a common jurisdiction of selection), and are usually governed by legal documents, such as articles of system, and a partnership agreement or operating agreement.

The GP/Managing director: Investment Advisers Act of 1940 and Related State Laws

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 amended Advisers Deed Section 203 to exempt from registration investment advisers that manage but venture capital funds. SEC Release No. IA-3222 (2011) defines a venture capital fund as any individual fund that:

Represents to investors and potential investors that information technology pursues a venture capital strategy;

Invests no more than 20 percentage of the amount of the fund'south aggregate capital contributions and uncalled committed capital in assets (other than brusque-term holdings) that are not qualifying venture capital investments, valued at cost or fair value;

Is non leveraged (except certain short-term loans equal to less than 15 percent of the fund's amass upper-case letter contributions and uncalled committed capital, for a non-renewable term of no longer than 120 calendar days);

Only issues securities that do not provide liquidity to investors, except in extraordinary circumstances; and

Is non registered nether the Investment Visitor Human activity (discussed beneath), and likewise has not elected to be treated as a business development company under the Investment Company Act.

Thus, venture capital managers must follow these guidelines if they wish to avoid registration with the SEC as an investment adviser.

Sure venture upper-case letter managers prefer to utilize strategies that, for example, provide some liquidity to their investors, and thus may utilise the "private fund" exemption from registration under the Advisers Human action, rather than the "venture capital" exemption. Under the Advisers Act, investment advisers with "assets under management" (AUM) of under $150mm are not required to fully register with the SEC. Instead, they must file but the first role of Form ADV as an exempt reporting adviser.

Even if non registering with the SEC as a upshot of an exemption, an adviser may still exist required to register as an investment adviser in the state where the adviser has its principal office and place of business organisation. In full general, most states have an exemption from state-level registration for advisers that advise fewer than five clients. A venture capital fund would exist considered one client as long as the adviser provides investment communication to the fund only (not the individual members/investors of the fund).

The police in this area is of meaning focus for the SEC, especially as it relates to managers raising capital on behalf of funds. Federal and country securities laws require persons who are banker-dealers to register and become members of FINRA. The definition of a broker-dealer is very wide and can include managers that solicit investors to invest in a fund.

Every bit an example of the changing police in this area, on Aug. 18, 2016, the SEC approved FINRA's Capital Acquisition Broker (CAB) rules, which state that a private fund manager that is solely engaged to advise a private fund concerning its securities offerings or other capital raising activities must now register as a CAB, which is akin to a limited broker-dealer registration. If a venture capital adviser intends to play a role that will solely exist to suggest a fund concerning its securities offerings or other majuscule raising activities, (and will not provide other managerial or informational services), the adviser may yet need to register every bit a CAB.

The Fund Itself: Investment Company Act of 1940

Under the Investment Company Act, a venture uppercase fund likely does not need to register with the SEC as an investment company every bit long as it has fewer than 100 investors who obtained their securities in a individual placement. For the purposes of calculating the number of investors under this rule, a "expect through" approach is used and each member of a fund is counted toward the 99 or fewer investors allowed under the exemption.

Securities Laws: Federal and Land

Dominion 506(b) of Regulation D under the Exchange Human action of 1934 allows an unlimited amount of coin to be raised in individual placements of a fund'due south securities from an unlimited amount of accredited investors. There are several other pertinent restrictions related to this exemption, such as a prohibition on general solicitation and a cap on the number of unaccredited investors allowed in an offering.

In other words, venture capital letter funds generally raise money in not-public securities offerings only available to high cyberspace worth individuals, alimony funds, insurance companies and other sophisticated, accredited investors.

"Blue Sky" observe filings are made in most states when conducting a private placement of securities. Some states have a de minimis exemption from such observe filing if only a small number (such as fifteen or fewer) of potential investors are offered or sold securities. For the abstention of doubt, this de minimis exemption is a carve up requirement from the "nether 5 customer" dominion under the Investment Directorate Act discussed in a higher place. As each state's Blue Sky laws are different, this is a complicated area that requires shut attending, and generally, the assistance of qualified legal counsel.

United States Internal Revenue Code of 1986

There are a number of tax problems related with the pass-through revenue enhancement of limited partnerships and limited liability companies such as venture capital funds. Additionally, at that place are a number of tax provisions that exist in lodge to encourage investment in venture uppercase companies, such as the qualified small business organization stock (QSBS) exclusion under Section 1202 of the Internal Revenue Code.

Conclusion
The purpose of this foregoing discussion is to help the reader in understanding the basics of the laws underlying the decision to start a venture capital fund. It is critical to consult with knowledgeable advisors before organizing a fund, including legal counsel that can help with incorporation, structuring and other fund-related issues, such every bit revenue enhancement and securities law.