More SEC Guidance To Avoid Blowing The Venture Fund Adviser Registration Exemption

The SEC has just published additional guidance for those venture capital funds advisers relying on an exemption to not  register as investment advisers under the Investment Advisers Act of 1940, and who may worry that the way they  structured a fund (or whether certain actions discussed below) might jeopardize the ability to rely on the exemption. In response to such inquiries, the SEC’s Division of Investment Management has provided additional guidance in the form of five examples or “scenarios” for advisers relying on the “venture capital fund” exemption or “VC Exemption” where they advise one or more venture capital funds. First, some background:

The Dodd-Frank Act created three exemptions from registration under the Advisers Act. One of them, section 203(l) of the Advisers Act, provides that an investment adviser that solely advises venture capital funds is exempt from registration under the Advisers Act.  Rule 203(l)-1 of the Advisers Act defines “venture capital fund,” and, generally, defines it as a private fund that (i)  holds no more than 20 percent of the fund‘s capital commitments in non-qualifying investments (other than short-term holdings); (ii) does not borrow or otherwise incur leverage, in excess of 15% of the fund’s aggregate capital contributions and uncalled capital commitments, and then only on a short-term basis; (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as pursuing a venture capital strategy to its investors and prospective investors; and (v) is not registered under the Investment Company Act and has not elected to be treated as a business development company.


The first scenario involves venture capital funds who hold their portfolio company investments through an intermediate holding company. The SEC has said it would not object if an intermediate holding company is wholly owned collectively by more than one venture capital fund advised by the same investment adviser (or its related persons).


The second scenario involves situations where funds advisers accommodate U.S. tax-exempt and non-U.S. investors by forming an alternative investment vehicle (“AIV”) that is separate from the venture capital fund and that will elect to be taxed as a corporation.  Since the AIV does not invest in “qualifying investments” and would therefore technically be holding more than 20% of the amount of the fund’s aggregated capital contributions and uncalled capital commitments in non-”qualifying investments,” the SEC has said it would not object if an adviser relying on the VC Exemption disregards AIVs when determining whether it can meet the requirements of the VC Exemption provided certain conditions are met.


The third scenario involves warehousing arrangements  where advisers may not yet be able to make investments,  and may need to wait to transfer securities of the investment to the venture capital fund upon the fund’s closing.  The SEC has said it would not object to an adviser treating a warehoused investment as if it were acquired directly from the qualifying portfolio company for purposes of the definition of “venture capital fund” under Rule 203(l)-1 provided certain requirements are met.


The fourth scenario occurs in situations where an adviser establishes a venture capital fund or “Main Fund” and one or more private funds to invest in parallel with the Main Fund or “Side Funds.”  An adviser might later close the Main Fund and form a Side Fund(s) after the Main Fund has made portfolio company investments.  Would the Main Fund’s transfers of portfolio securities to a Side Fund be deemed a non- “qualifying investment” for the Side Fund because the equity securities of the portfolio company that are transferred to the Side Fund are being acquired from the Main Fund and not directly from the qualifying portfolio company?

The SEC, in response, said it would not object to an adviser treating the Side Fund investment as if the Side Fund acquired the portfolio company securities directly from the qualifying portfolio company meeting the definition of “venture capital fund” under Rule 203(l)-1, ”as long as such transfer occurs within 12 months of the final closing of the Main Fund and the potential for this type of transfer is fully disclosed in the constituent documents of the Main Fund and any Side Fund(s).”


The final scenario involves situations where an adviser determines to wind up the remaining affairs of a venture capital fund by transferring the remaining portfolio securities of the fund to a liquidating trust where the adviser or an affiliate serves as the liquidating trustee. Does the fact that the liquidating trust obtains securities from the venture capital fund itself and not directly from a qualifying portfolio company deem it a non-”qualifying investment? In such circumstances, the SEC says it would not object to the adviser’s use of a liquidating trust while relying on the VC Exemption.

The Division of Investment Management’s IM Guidance Update (December 2013) can be found at

Author: Dexter Johnson

The author is a an attorney who for the past 14 years has concentrated his practice in representing, successfully, investment advisers, broker-dealers, corporations and individuals who are subject to SEC, FINRA, State or other regulations and who may be the subject of regulatory examination, review or investigation. He formerly worked at the SEC. His regulatory and litigation experience has encompassed virtually every type of securities issue in the industry. He has also negotiated favorable outcomes in many of these matters for his clients.