How Do You Know If You’re a Venture Capital Fund? Because You Say You Are

Gosh, the SEC is so helpful. Here it is newly explaining what a venture capital fund is in a new proposed rulemaking exempting VCs from registration:

Definition of Venture Capital Fund

The Dodd-Frank Act amended the Advisers Act to exempt advisers that only manage venture capital funds from registration under the Advisers Act, and the Commission was directed to define the term “venture capital fund.” The Commission is proposing a definition of “venture capital fund” that is designed to effect Congress’ intent in enacting this exemption. Under the proposed definition, a venture capital fund is a private fund that:

  • Represents itself to investors as being a venture capital fund.
  • Only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash.
  • Is not leveraged and its portfolio companies may not borrow in connection with the fund’s investment.
  • Offers to provide a significant degree of managerial assistance, or controls its portfolio companies.
  • Does not offer redemption rights to its investors.

Under a proposed grandfathering provision, existing funds that make venture capital investments would generally be deemed to meet the proposed definition, as long as they have represented themselves as venture capital funds. The Commission is proposing this approach because it could be difficult or impossible for advisers to conform existing funds, which generally have terms in excess of 10 years, to the new definition.

This is delightfully vague, but I can already see a couple of problems. For example, if a VC buys out the interests of other investors, the SEC says you’re not a VC anymore. I can think of many times when that proposed guideline has been broken. Further, you can only have called capital in cash or 60-days Treasuries? That’s been broken too.

Next up, portfolio companies can’t borrow in connection with the fund’s investment? That would seem to preclude obtaining a credit line, wouldn’t it? That often happens after a financing, so I guess it’s newly out.

I really dig the idea of offering to provide significant managerial assistance, if only because the word “offer” is so funny in the context. They can offer, but who knows if they’ll follow through, or if anyone will want them.

Finally, what do they mean by redemption right? Does that mean investors have to be locked up for the life of the fund and they can’t be bought out, or be assisted in transferring their LP interests. If so, more problems.