TALK BACK: The S.E.C. Defines Venture Capital

Yesterday, the U.S. Securities and Exchange Commission made public its definition of venture capital firms for the purposes of exemption from SEC registration requirements.

VCs and the NVCA hoped, with bated breath, that few if any VC firms would get sucked into the same category as private equity and hedge funds. But even exempt firms face some filing requirements and could be subject to SEC examinations under a separate SEC rulemaking. (Austin Ventures recently hired a combination compliance officer and general counsel, raising questions about the extent of such requirements. In addition, speculation has emerged regarding whether Austin Ventures could be re-classified.)

Yesterday’s announcement could have substantial reverberations throughout the venture investing world. But VCs aren’t getting caught off-guard. This February, speaking before a Philadelphia audience, Union Square Ventures’s Fred Wilson told conference-goers that USV would structure its funds in any way necessary to avoid being heavily regulated. Now, the question is, will he and USV have to do that?

Since the decision has been publicized, we are weighing in with analysis. But, VCs, once again, we’re counting on you to fill in the blanks here. How would the re-classification of your fund impact your business? Do you expect the S.E.C.’s definition will impact you at all? Will having to disclose confidential information jeopardize investments and portfolio strategy? Or will it only touch on the biggest VC firms in the U.S.? And, if that is the case—will this represent a leveling of the playing field for smaller venture capital firms? And, perhaps most important—will you fight the definition? Comment below!!


  • Why not let entrepreneurs proffer their views?

  • Dave Rusin’s got an excellent point–we forgot to lump entrepreneurs into this category. We’re not trying to exclude any category of professional, and when the S.E.C. does issue its ruling on how VCs will be classified–we’re hoping for between 10AM and 11AM today–we’d like to get your take, as well, Dave.

    Clearly, Austin Ventures’ personnel move is an ominous one, and it’s possible other venture capital firms will have to make similar hires–and expenditures. Entrepreneurs, if they are working for VCs that are included under more stringent regulatory disclosure requirements via today’s S.E.C. ruling, might find themselves facing greater pressure to provide updated, confidential data. At a time when the federal government is struggling against loosely-affiliated hacker networks, entrepreneurs will understandably be worried about how well their business plans are guarded.

  • Thanks for the article Jonathan.

    As an addendum, Fred Wilson made that point in response to my question at the Wharton PE and VC conference. And I agree with the thoughts; the VC space is trying to emerge more strongly and more regulations will only hamper the innovation required in both the the entrepreneurial and VC sides of the table.

    Would be happy to chat more.



  • OK, we’re at long last underway; peHUB readers can view the meeting here:

  • Here are the recommendations—this is not final, and commissioners are weighing in with comments and questions right now:

    The fund can pursue “qualifying investments,” with an exemption for 20% of the VC’s capital commitments
    The fund can’t leverage itself with more than 15% of its capital
    The fund cannot offer investors short-term liquidity except in certain circumstances
    The fund must “represent itself” as pursuing a venture capital investment strategy
    And, lastly,
    The fund cannot register as a BDC.

    Commissioner Walter suggests the number of investment advisers that would be exempt has shrunk from around 4,200 to closer to 3,200—that’s 1,000 more firms’ worth of information the S.E.C. might need to process. Sounds like they will need even more personnel.

  • Here’s the response we got from Mark Heessen at the NVCA:

    “We are pleased to see that the SEC recognized the need for flexibility in defining venture capital by creating a 20 percent basket for fund activity which falls outside the rule. However, there are details of the ruling that have yet to be shared, including certain allowable activities for qualifying firms which we recommended in our comment letter. We will wait for those details before issuing a full response.”

  • Clarifying myself here, the number of investment advisers that will be exempted also puts an increased burden on state legislatures that now have to set up more oversight on funds the S.E.C. just downgraded to their jurisdiction. It comes at a bad time for many statehouses, if they need to beef up investigatory and compliance efforts to weed out fraud/abusive investment practices.

    Further, I think the biggest impact the ruling has is that, as of right now, venture capital firms that invest in late-stage biotech companies are staring at a requirement that says they’re only allowed to put 20% of their aggregate capital to use making additional investments in companies once they’ve gone public. Additionally, if they want to make other investments that fall out of the realm of “qualifying investments,” they would have to scale back investing in public companies even further. This seems to make an IPO a less attractive financing opportunity for venture capitalists, and they may instead turn to secondary markets to raise capital–especially if they view that asset as one they’d want to double down on.

  • What’s striking to me is that the SEC is clearly investing serious firepower in this area. This reminds me of an old joke:

    A drunk loses the keys to his house and is looking for them under a lamppost. A policeman comes over and asks what he’s doing.

    “I’m looking for my keys” he says. “I lost them over there”.

    The policeman looks puzzled. “Then why are you looking for them all the way over here?”

    “Because the light is so much better”.

    The US financial regulatory apparatus looks terrible now because of the Madoff scandal (which was not a hedge fund) and the 2008 financial meltdown (caused by the large banks/mortgage companies, bad regulation, quasi-government agencies like Fannie/Freddie, and consumers who took on too much debt). So now they’re focusing their investigative energies on hedge funds and VCs, whom virtually everyone agrees bear no responsibility for the 2008 crisis. Why? Mainly because those are two groups who do not have the regulatory sway and lobbying budget of the large investment banks. This seems like a misuse of our taxpayer dollars, to put it mildly.

  • The SEC should increase investors from 500 to 2000 before having to file like a public company information about a company.

    This will keep a lot of people honest that are not responsive to entrepreneurs, marginalize their ideas especially if they are good ideas to steal a deal and; in the American spirit, theoretically an entrepreneur with experience and business acumen has another option to raise funds and be rewarded for their innovation … fairly.

    Maybe more professional investors would return calls in the first place … make quicker decisions (even if its “no”) and start looking at opportunity differently.

  • Congress also should loosen some of the demand in Sarbox for small, emerging companies interested in going public. But this alone will not improve IPO markets. What we need are public market investors willing to buy risky shares. And we haven’t had that for years. What generates that are solid relatively mature startups with truly innovative technology. It all comes down to the innovation cycle. So anything we can do to spur innovation is key, whether it is government spending on basic research or VCs really willing to look to the future.

  • I had an opportunity to speak with a VC familiar with the SEC-VC definition, who unequivocally called Wednesday’s announcement a win for venture capital firms. Why? VCs, my source said, had much lower expectations regarding the SEC’s decision. Venture capital firms had initially expected that, instead of the 20% “non-qualifying” investments threshold the commission granted, they could be limited to as little as five percent. That’s a very sizeable difference. Because secondary markets don’t tell us who invests in what, there is no way to tell which VCs have been spending the most to buy stakes there. But, rest assured, there are a few that have spent well in excess of five percent of their current fund’s value buying stakes via secondary market purchases.

    Further, my source adds, the 20% threshold represents a break–and not a hindrance–to companies in the life sciences/biotech arena that need to make additional post-IPO investments in companies. Were they limited to only being able to deploy five percent of their aggregate capital into post-IPO investments, this would actually potentially mean a windfall for secondary markets, if they could successfully draw a wide range of late-stage biotech and medical device companies into their auctions. Finally, says my source, it remains wholly possible that VCs with these healthcare-related investments will STILL opt for secondary market deals for the assets they plan to re-invest in, instead of taking them public.

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