Dodd-Frank imposed registration requirements on advisors of hedge funds. The act exempted venture capital funds but left it to the SEC to define these funds. The SEC has now proposed a definition as part of new rules implementing Dodd-Frank’s hedge fund provisions. According to the SEC’s press release, 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), U.S. 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.
The rule grandfathers existing funds that have represented themselves as venture capital funds “because it could be difficult or impossible for advisers to conform existing funds, which generally have terms in excess of 10 years, to the new definition.”
But the SEC feels comfortable locking new funds into terms that could constrain their activities for long periods in a dynamic investment environment. Although today’s VC funds may conform to the SEC’s definition, it is not clear that they will always want to, say, avoid debt or redemption rights. The costs associated with this inflexibility are especially problematic given VC funds’ need to adjust to the drop in initial public offerings, which traditionally provide a critical opportunity to exit from investments.
Real unemployment is climbing toward 20% and new firms with new ideas can create jobs. Venture capital is a key mechanism for funding start-ups. Somebody should pass this information onto the SEC.