Venture Firms Win Favorable SEC Decision On Fund Registration

The Securities and Exchange Commission adopted a definition of the venture capital industry that will permit VCs to operate largely as they currently do, a decision some GPs are calling a victory for the asset class.

Details of the decision have yet to be released, and are expected in the next few days. However, the definition’s framework appears to grant firms enough latitude during deal making to continue funding startups without being required to devote significant resources to registration.

The rules, which were adopted by a 5-0 vote, lock into law the exemption from registration the Dodd-Frank Act extended to the industry. In doing so, it creates an industry definition that allows venture partners to invest up to 20% of a fund in so-called non-conforming investments without triggering registration demands.

These so-called non-conforming activities might include buying shares of a startup on the secondary market, borrowing during a company financing, or purchasing shares of a startup after it has gone public. The Dodd-Frank Act viewed the industry’s general operations, funding emerging companies through equity investments for the purposes of expanding company operations, as not posing a systemic risk to the U.S. economy. This is largely because venture capitalists don’t use leverage in their investments.

“We believe the vast majority of our members will be able to fall within the (SEC’s) venture capital definition” and avoid registration, said Mark Heesen, president of the National Venture Capital Association, which represents 400 firms. “We’re cautiously optimistic.”

The printed copy of the industry definition is to be released by early next week. The NVCA had previously sought greater flexibility from the SEC on allowing venture capital firms to re-invest in assets post-IPO, stating in a letter to the commission that companies’ access to later-round investments from VCs is “critical for the support of companies such as those in the life science area that continue to need significant financial resources after an IPO in order to become viable and cash-flow positive.”

The new rules brought immediate relief from GPs. It appears “we’re not going to have to change the way we operate,” said Mike Elliott, managing partner of the Atlanta-based firm Noro-Moseley Partners. “I think this is good news.”

Elliott said that if his mid-sized firm was forced to register, it would have had to transfer an investment partner to the role of registration compliance officer.

And yet some threads remain untied. Jonathan Axelrad, a partner at the law firm Goodwin Procter, pointed out that until the text of the definition is released, details remain unclear.

He also noted that the SEC appeared to back rules forcing general partners to provide at least some amount of “high level” fund information about their funds and operations on ADV form Part 1.

“Overall, the commissioners indicated that this rule making process was about balancing the interests of the venture capital industry to be protected from unnecessarily burdensome regulation and providing the SEC with the information it believes it needs to protect investors and the economy,” he said.

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