This is the ninth post in a series exploring recent SEC regulations that define the term “venture capital fund” for the purposes of determining whether a fund’s manager is exempt from SEC registration requirements under the Dodd-Frank Act.
Previously in the first installment of this series, I provided a general overview of how the SEC has defined the term “venture capital fund.” A private fund manager that solely advises venture capital funds (as defined in SEC regulations) qualifies for an exemption from investment adviser registration under the Investment Advisers Act. There are five elements to the definition. The first element is that the fund must represent to investors and potential investors that it pursues a venture capital strategy. The second element is that no more than 20% of the fund’s total assets (including committed but not yet invested capital) can be invested in assets that are not “qualifying investments” or “short term holdings.” The third element is the fund cannot borrow in excess of 15 percent of the fund’s aggregate capital contributions and uncalled committed capital. The fourth element is that the fund cannot provide its investors with redemption rights, except in “extraordinary circumstances.” In this post, I will discuss the fifth and final element of the definition, which prohibits a VC fund from registering as an investment company.
The SEC regulations require that in order for a fund to qualify as a venture capital fund, it must (i) not be registered under the Investment Company Act of 1940 and (ii) not elected to be treated as a business development company pursuant to the Investment Company Act. This requirement should not significantly affect most venture capital funds.
Typically, funds that are registered as investment companies are publicly traded mutual funds. Most venture capital funds, on the other hand, are private funds, which are funds that are exempt from the registration provisions of the Investment Company Act. A venture capital fund typically uses one of two exemptions: the “3(c)(1)” exemption or the “3(c)(7)” exemption. The 3(c)(1) exemption exempts from Investment Company Act registration any fund with 100 or fewer investors. The 3(c)(7) exemption exempts from Investment Company Act registration any fund that is sold exclusively to qualified purchasers (which roughly speaking, is a person or entity with $5 Million or more in investment assets). Practically speaking, this means that private funds, such as venture capital funds, are either (i) limited to 100 or less accredited investors or (ii) limited to 499 or less qualified purchasers.
The venture capital exemption from investment adviser registration does not apply to advisers to a fund which has elected to be treated as a business development company under the Investment Company Act. A business development company is a form of publicly traded private equity fund designed to provide capital to small, developing, and financially troubled companies.  Advisers to such funds will be required to register as an investment adviser with the SEC, unless another exemption applies.
As always, you should consult an attorney who is familiar with securities regulatory issues in assessing whether your particular fund management business is required to register with the SEC.
 The reason 3(c)(1) funds are usually limited to accredited investors is that doing so makes it easier for the fund to conduct a Rule 506 offering, exempting the fund’s securities from the registration provisions of the Securities Act of 1933. The 499 investor limit for 3(c)(7) funds is the result of the Securities Exchange Act of 1934, which requires public company reporting for any company which has more than 499 owners and more than $10 million in assets.
 For more information on business development companies, see http://www.gibbonslaw.com/files/1173712565.pdf.
© 2011 Alexander J. Davie — This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.