Defining VC

Although venture funds are exempt from registering with the SEC under the Dodd-Frank Act, determining the definition of venture capital proved tricky, writes Jenna Gottlieb.

We now know what constitutes a venture capital fund in the eyes of the US Securities and Exchange Commission. And, there isn’t much wiggle-room for private equity funds hoping to “redefine” themselves.

At the behest of Congress, the SEC aimed to give greater shape to venture capital exemptions put forth by the financial reform bill passed earlier this year.

The SEC last week determined that 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), US 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.

Jenna
Gottlieb

The SEC’s first bulletpoint drew giggles from one fund formation lawyer. “It’s silly. If I call myself a venture capital fund, then I am. You don’t see that kind of language from the SEC every day.”

The remaining points, however, were not amusing. “The carveout for venture is very clear in these rules. It’s a big win for the VC industry, but crushed any hope for the PE players,” said the lawyer.

SEC Chairman Mary Schapiro said in an open meeting last week that venture capital is focused on starting companies, not buying them out. Shapiro acknowledged, however, that coming up with the definition was challenging.

“This is a challenging line-drawing process,” said Shaprio, at the meeting.

The agency is looking “to finalise these rules in advance of the one year deadline to give clarity to advisors seeking to determine their registration status before next July”, Schapiro added.

The SEC will begin a 45-day public comment period following the proposed rule's publication in the Federal Register, which is expected within days.