When the Dodd-Frank financial reform bill was finalized earlier this year, venture capitalists breathed a collective sigh of relief. Gone was the requirement that VC fund managers register with the SEC under the so-called Advisors Act — a process that smaller firms felt would be cost-prohibitive.
But there was one outstanding issue: The bill didn’t actually define “venture capital fund.” Instead, it kicked that can over to the SEC.
Late this afternoon, the Commission released its first stab at the definition. This is just a proposal, with public comment welcomed over the next 45 days.
According to the SEC, 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.
On first blush, this is a pretty decent attempt. But…
Some of the qualifications are a bit silly — calling yourself a “venture capital fund” is key to being deemed a venture capital fund? — and I could see some trouble with the “equity securities” issue (convertible notes?). And who will define if the investment is used primarily for operating or business expansion capital? Don’t venture capital investments sometimes get used, in part, to acquire complementary companies or smaller rivals? And then there is that whole thing about not buying out other investors (would the last Foursquare round not qualify?).
Maybe some percentage thresholds would help…
Look, VC fund registration/definition is virtually impossible to do perfectly. Some firms that should qualify won’t, and some firms that shouldn’t qualify will. Moreover, it would seem that VC firms will be asked to police themselves. After all, there is no suggestion in these rules that the SEC can audit a VC fund’s investments, to make sure that the portfolio meets the definition. And, if that power is granted, registration would seem easier (and cheaper).
It will be interesting to see how the industry reacts over the next 45 days…