SEC Adopts Final Rules Regarding Advisers to 'Venture Capital Funds' Exempt from Registration as Investment Advisers

April 11, 2011


The Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd-Frank"), effective July 21, 2010, amended the Investment Advisers Act of 1940, as amended (the "Advisers Act"), to provide an exemption from the obligation to register under that Act for persons who provide advice solely to "venture capital funds".  On June 22, 2011, the Securities and Exchange Commission ("SEC") adopted investment adviser rules implementing this exemption, including a final rule defining "venture capital fund" under Section 203(l) of the Advisers Act (the "Venture Capital Exemption"). See "Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers," Investment Advisers Act Release No. 3222 (June 22, 2011), available at (the "Release"). At the same time, the SEC adopted rules and rule amendments that require advisers who are exempt from registration either under the Venture Capital Exemption or under a new exemption for advisers to private funds with less than $150 million in assets (collectively, these two types of advisers are "Exempt Reporting Advisers"), to file certain reports with the SEC. See "Rules Implementing Amendments to the Investment Advisers Act of 1940," Investment Advisers Act Release No. 3221 (June 22, 2011), available at (the "Implementing Release"). The SEC was empowered under Section 407 of Dodd-Frank to adopt these regulations effective July 21, 2011, but the effective date for enforcement of many of the relevant rules has been delayed to March 30, 2012.  An investment adviser solely to a venture capital fund meeting the definitions ("Venture Fund") in the new Rule 203(1)-1 as set forth in the Release (the "Final Rule") will not be required to register as an investment adviser under the Advisers Act, but will be required to effect the filing of certain reports under the Advisers Act as set forth in the rules for reporting set out in the Implementing Release ("Implementing Rules") and is subject to the possibility of SEC examination.

This memorandum focuses on the Venture Capital Exemption and the reporting obligations of advisers who intend to utilize it.  Advisers to capital pools which do not meet the definition of Venture Funds now need either to restructure or to register under the Advisers Act (see the part of this memorandum entitled "What To Do Now?").  It should be recalled that there are also several other exemptions and exclusions from registration for which advisers and capital pools may qualify. 


Prior to July 21, 2011, most advisers to venture capital funds that were within the definition of an "investment adviser" under the Advisers Act relied upon the "private adviser exemption" from registration under Section 203(b)(3) of the Advisers Act.  Former Section 203(b)(3) exempted from registration an investment adviser if, among other things, the person advised fewer than 15 clients during the immediately preceding 12-month period and did not "hold itself out" generally to the public as an investment adviser (the "Private Adviser Exemption").  The Private Adviser Exemption was the exemption relied upon by many advisers to futures funds, hedge and private equity funds, family offices, foreign-based advisers and others.

Dodd-Frank rescinded the Private Adviser Exemption effective July 21, 2011.  Now, most fund advisers are required to register as "investment advisers" under the Advisers Act and to comply with substantial disclosure, reporting, recordkeeping, operational and SEC examination obligations.  However, the Advisers Act, as amended by Dodd-Frank, now also includes new exemptions from registration for advisers to some "private funds," including a new Section 203(l) exemption for private fund advisers that solely advise Venture Funds.  Under Dodd-Frank, a "private fund" is defined as any issuer that would be an investment company under Section 3 of the Investment Company Act of 1940 (the "Company Act") but for the exclusion from the definition of "investment company" set forth in Section 3(c)(1) or 3(c)(7) of the Company Act (i.e., the fund is not sold in a public offering and is either beneficially owned by fewer than 100 holders or owned exclusively by "qualified purchasers").  To qualify as a Venture Fund adviser, a private fund manager must manage only qualifying funds and not other types of funds and must not provide investment advisory services to other clients, such as separate accounts or pooled employees' securities; there is some risk, for example, that a single-investor vehicle is likely to be viewed by the SEC as equivalent to a separate account and thus not as a private fund. 

The Release addresses, among other things, the scope and nature of the Venture Capital Exemption, and the Implementing Release imposes specific reporting obligations on advisers relying upon this exemption.  The Final Rule defines "venture capital fund" in a manner that should exempt from registration under the Advisers Act most firms generally considered to be "venture capital firms" under common industry usage.  The Implementing Rules, which include an amended Form ADV Part 1A and related materials, set forth final, detailed reporting requirements focused on Venture Funds managed by Exempt Reporting Advisers, among others.  The Implementing Rules require Exempt Reporting Advisers to complete and file as reports significant portions of Form ADV Part 1A.

This memorandum is focused upon the Final Rule and those aspects of the Implementing Rules most applicable to Exempt Reporting Advisers for Venture Funds.  Such advisers should note, however, that Dodd-Frank itself was structured in a manner that causes Exempt Reporting Advisers to remain subject to the SEC's authority to require recordkeeping and reporting and, perhaps most significantly, to the SEC's examination authority.[1]  The SEC has also noted that Exempt Reporting Advisers may in any event also be subject to state registration and other requirements. 

The Final Rule's Five Part Test

The SEC issued the proposed exemption for advisers to venture capital funds on November 19, 2010[2] and requested comments by January 20, 2011.  The definition of venture capital fund that the Commission originally proposed focused on distinguishing a venture capital fund from hedge funds and private equity funds by imposing restrictions on a Venture Fund's investments and fund-level operations.  In response to numerous comments received by the SEC, the definition of Venture Fund in the Final Rule, although still limiting, is not as restrictive as the definition originally proposed, principally because of the inclusion of a 20% "basket" for non-qualifying investments which may be held by a Venture Fund and because the Final Rule does not include any requirement that the Venture Fund adviser be involved in the management of its portfolio companies. 

The Final Rule sets forth five basic requirements for a private fund to be a Venture Fund:

1. Only Qualifying Investments and Short Term Holdings with a 20% Basket.  Qualifying investments generally consist of equity securities of qualifying portfolio companies that are directly acquired by the Venture Fund.  The fund should hold, immediately after the acquisition of any asset, only qualifying investments and short term holdings (see below) and other investments (in an amount equal to no more than 20% of the Venture Fund's total capital commitments) in "not qualifying" investments (see below regarding the "Basket");

2. No Leverage.  The fund shall not borrow or otherwise incur leverage other than limited short-term borrowing (excluding certain guarantees by the fund of qualifying portfolio company obligations);

3. No Early Redemption.  The fund shall not offer its investors early redemption or other similar liquidity rights except in extraordinary circumstances;

4. Venture Capital Strategy.  The fund represents itself to its investors and prospective investors as pursuing a venture capital strategy; and

5. Not Registered Investment Company.  The fund must not be registered under Section 8 of the Company Act and has not elected to be treated as a "business development company" under Section 54 of the Company Act.

1.         Qualifying Investments; Short Term Holdings; Basket

The fund must own only (i) equity securities issued by qualifying portfolio companies, (ii) cash, certain cash equivalents and U.S. Treasury securities with a remaining maturity of 60 days or less, and (iii) "Basket" interests (see below).

Equity Securities.  The Final Rule maintains the proposed rule's definition of "equity securities" which is taken from Section 3(a)(11) of the Securities Exchange Act of 1934.  In general, equity securities include (i) common and preferred stock, (ii) warrants, convertible debt (e.g., convertible bridge loans), and other securities that are convertible into stock, and (iii) certain limited partnership interests.  Significantly, "straight" (i.e., non-convertible) debt is not treated as an equity security for this purpose.  The SEC's definition of "equity securities" that a venture capital fund may acquire includes "instruments that are ultimately convertible into a portfolio company's common or preferred stock at a subsequent investment stage" and is intended to include many of the types of bridge financings that venture capital funds provide to portfolio companies.  With respect to each qualifying portfolio company, at least 80% of the equity securities held by the Venture Fund still must have been acquired directly from the company, rather than from the company's existing shareholders.

The Final Rule also maintains the earlier proposed requirement that a qualifying portfolio company not be a public company or a control affiliate of a public company (or foreign traded).  However, since the definition of qualifying portfolio company looks to the time of investment, a Venture Fund can continue to hold public securities after a qualifying portfolio company's initial public offering. Follow-on investments in a public company, however, would not qualify and instead would be non-qualifying investments subject to the Basket.

A qualifying portfolio company also cannot itself be a private fund, so an investment in another Venture Fund or other fund would not be a qualified portfolio company.  The SEC in the Release, however, states that wholly-owned holding companies formed for tax, legal or regulatory reasons would not preclude qualifying portfolio company status.  As a result, some commentators anticipate that the Basket (see below) will be used by Venture Funds that make, among other investments, non-convertible bridge loans or other debt investments, investments in public companies (whether PIPEs, follow-ons or otherwise), direct secondary acquisitions of stock, investments in other private funds and non-permissible short-term investments.

Secondary Acquisitions.  Although all qualifying investments must be equity securities of qualifying portfolio companies that are originally issued by the qualifying portfolio company (or shares received in certain exchanges for qualifying portfolio company shares), under the Final Rule, direct secondary acquisitions may be made by a Venture Fund only as non-qualifying investments subject to the 20% Basket (see below).

Under the proposed rule, direct secondary acquisitions of qualifying investments would have been permitted in an amount up to 20% of the amount invested by the Venture Fund in any particular qualifying portfolio company (on a company by company basis), but indirect secondary acquisitions would not have been permitted. This is because, under the proposed rule, a qualifying portfolio company was not permitted to redeem or repurchase stock or distribute assets "in connection with" the Venture Fund's financing.  In the Final Rule, the Commission deleted the specific qualifying portfolio company redemption/repurchase/distribution limitation impacting indirect secondary acquisitions. This may provide additional liquidity to founders and employees of venture-backed companies who may want to sell personal equity to Venture Funds.

Qualified Portfolio Company Leverage.  Under the proposed rule, a qualifying portfolio company would not have been permitted to borrow "in connection with" the Venture Fund's equity financing of the company.  Commentary to the SEC regarding the proposed rule indicated that this language gave rise to uncertainty regarding qualifying portfolio company borrowing that was not within the Venture Fund's control and suggested that any prohibition be based instead on use of proceeds.

Under the Final Rule, the Commission instituted a two-part test for prohibited qualifying portfolio company borrowing. A qualifying portfolio company's borrowing still will not be permissible if:

(1)        the borrowing was "in connection with" the Venture Fund's financing; and

(2)       the proceeds were distributed to the Venture Fund in exchange for the Venture Fund's investment.

Because it would be unusual for proceeds from qualifying portfolio company borrowing activities to be distributed to a Venture Fund, this should provide greater certainty to a Venture Fund as to qualifying portfolio company status.  The SEC commentary in the Release states that "subsequent distributions" to the Venture Fund solely because it is an existing investor in the qualifying portfolio company would not necessarily cause qualifying portfolio company borrowing "in connection with" a Venture Fund's financing to be impermissible.

Non-Qualifying "Basket".  The most important change from the proposed rule is the SEC's adoption in Final Rule 203(l)-1(a)(2) of a recommendation by the National Venture Capital Association ("NVCA") that Venture Funds be permitted to hold no more than 20% of the amount of the fund's capital in assets which are not "qualifying investments" (the "Basket").  Although the 20% Basket could have been measured based on invested capital or contributed capital, the SEC adopted the NVCA's recommendation that it be based on aggregate capital contributions and uncalled capital in order to provide certainty regarding the determination of the basket amount.

Further, the Basket assets are permitted to be valued at their historical cost which provides additional certainty as to the determination of whether the Venture Fund's Basket assets will fall within the 20% limit. Venture Funds may also choose to have Basket assets measured at fair value, but the cost or fair value methodology must be applied consistently throughout the term of the Venture Fund.

Perhaps as important, the determination of the 20% Basket calculation need only be made at the time of making an investment in a proposed Basket asset, based on the Basket asset held by the Venture Fund immediately after the asset acquisition.  The 20% threshold for non-qualifying investments is tested any time a fund makes an acquisition of any asset (other than qualifying investments or short-term holdings).  It does not mean that 80% of the fund's capital commitments must be invested in qualifying investments, as it is recognized by the SEC that a fund rarely invests 100% of its capital commitments.  For example, if a fund makes an investment in a non-qualifying investment that is equal to 8% of its capital commitments, and, on the date that investment is made, the fund has used 2% of its capital commitments to pay management fees, holds qualifying investments representing 65% of its capital commitments, and already holds non-qualifying investments representing 10% of its capital commitments, then the new 8% non-qualifying investment would be permitted because, immediately after its acquisition, the fund would still be holding only 18% of its capital commitments in non-qualifying investments.  Also, note that the space in the Basket will "free up" if the Venture Fund disposes of a Basket asset before the acquisition of another Basket asset.

2.         Short-Term Holdings and Fund Leverage

Under the proposed rule, a Venture Fund was only permitted to hold (in addition to qualified investments) cash and cash equivalents or U.S. Treasury securities with a remaining maturity of 60 days or less.  Under the Final Rule, short-term holdings may also include shares of an open-end management investment company that is regulated as a money market fund. Permissible short-term holdings are disregarded for purposes of the Basket determination, but otherwise impermissible short-term holdings would be included in the 20% Basket limit.

The Final Rule maintains the proposed rule's requirement that a Venture Fund may not borrow, issue debt obligations, provide guarantees or otherwise incur leverage in excess of 15% of the Venture Fund's aggregate capital contributions and uncalled committed capital.  While the Final Rule also maintains the requirement that any such borrowing, indebtedness or leverage has a non-renewable term no longer than 120 days, this time limit was eliminated for individual company guarantees up to the amount of the value of the Venture Fund's investment in each qualifying portfolio company.

3.      No early redemption of the interests of its own equityholders absent extraordinary circumstances, but may make distributions to all holders on a pro rata basis

As described in the Release for the proposed rule, "extraordinary circumstances" should include those common triggers for redemption, withdrawal or repurchase rights that typically are beyond the control of the adviser, such as illegality and changes in law.  A Venture Fund may provide extraordinary rights for an investor to withdraw from the fund under foreseeable but unexpected circumstances or to be excluded from particular investments due to regulatory or other legal requirements.  These events may be "foreseeable" because they are circumstances that are known to occur (e.g., changes in law, corporate events such as mergers, etc.) but are unexpected in their timing or scope.  Thus, withdrawal, exclusion or similar "opt-out" rights would be deemed "extraordinary circumstances" if they are triggered by a material change in the tax law after an investor invests in the fund, or the enactment of laws that may prohibit an investor's participation in the fund's investment in particular countries or industries.  The trigger events for these rights are typically beyond the control of the adviser and fund investor (e.g., tax and regulatory changes).  But, "a fund that permits quarterly or other periodic withdrawals would be considered to have granted investors redemption rights in the ordinary course even if those rights may be subject to an initial lock-up or suspension or restrictions on redemption."[3]  Also, the SEC has not discussed the meaning of "pro rata"; this could lead to some ambiguity in light of the typical allocation and distribution waterfalls which often include preferred returns to limited partners (over the general partner), the general partner "catch-up" allocations and distributions, and 80/20 carried interest splits.

The SEC chose not to include "fund of funds" within the definition of Venture Fund.  The Release also does not indicate how the SEC would treat less traditional venture fund structures, such as pledge funds or other vehicles in which investors have opt-out rights on an investment-by-investment basis.  Without further clarification, it is still possible that the SEC will now look through these types of vehicles as simply mechanisms for individual investments and require advisers to treat each investor as a client, making the venture capital exemption unavailable.

4.         Represented as Pursuing a Venture Capital Strategy

Both for purposes of the Venture Fund's definition and for prior funds to qualify for the "grandfathering" exemption, the Final Rule requires in Rule 203(l)-1(a)(1) that Venture Fund must have represented itself to investors and potential investors as pursuing a venture capital strategy.  The proposed rule had required the Venture Funds to have represented itself as a "venture capital fund."  Venture capital "strategy" is not defined in the Final Rule.  Under the Final Rule, a facts and circumstances test will apply to determine whether the representations to investors and potential investors described a venture capital strategy.  A Venture Fund should consistently represent itself as pursuing a venture capital strategy in offering materials, investor reports and otherwise.  Use of "venture capital" in a fund's name is not essential, but is part of the overall analysis of how the fund represents its investment strategy.

5.         Not a Registered Investment Company

Again, the fund must not be registered under Section 8 of the Company Act and not elect to be treated as a "business development company" under Section 54 of the Company Act.

Managerial Assistance/Control Not Relevant

Under the proposed rule, a Venture Fund was required to control a qualifying portfolio company or offer managerial assistance to the qualifying portfolio company. Since this requirement was viewed as not creating a significant benefit for investors or distinction from other funds, it was deleted by the SEC and is not in the Final Rule.

Grandfathering Exemption

As under the proposed rule, the Final Rule provides in Rule 203(l)-1(b) that the definition of a Venture Fund includes any private fund that (i) issued securities to one or more investors not related to the adviser prior to December 31, 2010, (ii) does not issue any additional securities after July 21, 2011, and (iii) represented to investors and potential investors at the time of the offering that it pursues a venture capital strategy (as described above).  A grandfathered fund thus includes any fund that had accepted all capital commitments by July 21, 2011, even if none of the capital commitments had been called by that date.  As a result, the Venture Fund must have held its initial closing before 2011 and its final closing prior to the original Dodd-Frank Act registration effective date of July 21, 2011 to qualify for the grandfathering exemption.

Implementing Rule's Reporting Requirements for Adviser Itself

Under the Implementing Rules, if an adviser is able to fall within the Venture Funds exemption, it will not need to register as an investment adviser, but it will be subject to the lesser level of regulation under the Dodd-Frank Act as an "Exempt Reporting Adviser".  Exempt Reporting Advisers are required to annually file and update certain parts of Form ADV Part 1.  Exempt reporting advisers to Venture Funds must submit their initial reports on Form ADV within 60 days of relying on the exemption from registration under section 203(l) of the Advisers Act.  Exempt reporting advisers must file their first reports on Form ADV with the SEC through the Investment Adviser Registration Depository ("IARD") operated by FINRA between January 1 and March 30, 2012. 

As noted above at footnote 1, an Exempt Reporting Adviser to a Venture Fund is subject to examination by the SEC.  The SEC has explicitly stated on several occasions (including in the Release and at the open meeting announcing it), that it does not intend to conduct routine compliance examinations of Exempt Reporting Advisers.  The SEC does, however, reserve its right to conduct "cause" examinations where there are indications of wrongdoing (i.e., prompted by tips, complaints or referrals).  We recommend being prepared at all times for such an examination. 

Rule 204-4 of the Implementing Rules requires Exempt Reporting Advisers to file the SEC's new Form ADV, Part 1A ("Uniform Application for Investment Adviser Registration and Report by Exempt Reporting Advisers"), which will be publicly available via the SEC's website.  However, unlike registering or registered advisers, Exempt Reporting Advisers only have to respond to the following items on Form ADV, Part 1A:

  • Item 1 (Identifying Information);
  • Item 2.B (SEC Reporting by Exempt Reporting Advisers);
  • Item 3 (Form of Organization);
  • Item 6 (Other Business Activities);
  • Item 7 (Financial Industry Affiliations and Private Fund Reporting);
  • Item 10 (Control Persons);
  • Item 11 (Disciplinary Disclosure); and
  • The corresponding sections of Schedules A, B, C and D.

Exempt Reporting Advisers do not have to complete the other Items in Part 1A or prepare a client brochure (Form ADV, Part 2).  However, Item 7.B and its related Schedule D section have been expanded to require significantly more types of information regarding private funds advised by Exempt Reporting Advisers.[4]  Advisers whose principal office and place of business is outside of the United States are not permitted to omit from Item 7.B information for private funds that are not organized in the United States and not offered to or owned by U.S. persons if those funds are treated as private funds for purposes of the Venture Capital Exemption.

The SEC also amended Rule 204-1 under the Advisers Act to require Exempt Reporting Advisers to amend their reports on Form ADV at least annually, within 90 days of the end of the adviser's fiscal year and more frequently if required by the instructions to Form ADV.  Additionally, General Instruction 4 to Form ADV requires an Exempt Reporting Adviser to promptly update Items 1 (Identifying Information), 3 (Form of Organization) and 11 (Disclosure Information) if they become inaccurate in any way and to update Item 10 (Control Persons) if such information becomes materially inaccurate.

The SEC Chairman indicated, in connection with the adoption of the Implementing Release on June 22, 2011, that the SEC will reconsider the reporting requirements of Exempt Reporting Advisers one year after the first reports are filed.

Implementing Rules' Adviser Reporting Requirements Regarding Private Funds

In the Implementing Rules, the SEC significantly amended Item 7.B and Section 7.B of Schedule D of Form ADV, Part 1A, the form that serves as the application for investment adviser registration and now also serves advisers to Venture Funds for reporting.  These parts of the Form ADV require advisers to identify and provide certain information, such as assets under management, for each "investment-related limited partnership" that the adviser or a related person advises.  The amendment requires advisers to provide information on "private funds" and expands the amount of information formerly required to be reported by registered advisers by adding basic organizational, operational and investment characteristics of each private fund, the nature of the investors in the fund, and the fund's service providers.  The amendment does not require advisers to report on private funds advised by related persons.[5]

  • As amended, Part A of Section 7.B requires:
    • Basic identifying information about the fund (including the name of the fund, the jurisdiction in which it was organized and the name(s) of the fund's general partner, directors or persons serving in a similar capacity);
    • Operational and structural information (including the strategy of the fund and whether it is part of a master-feeder arrangement);
    • The Company Act exemption on which it relies;
    • The name of any foreign regulatory authority with which the fund has registered;
    • The type of private fund (hedge fund, liquidity fund, private equity fund, real estate fund, securitized asset fund, venture capital fund or other type of fund);
    • The gross asset value of the fund;
    • The minimum investment amount;
    • The approximate number of beneficial owners; and
    • The approximate percentage of the fund owned by the investment adviser or related persons, by fund of funds and by non-United States persons.
  • As amended, Part B of Section 7.B requires identifying and other information on the fund's service providers, including auditors, prime brokers, custodians, administrators and marketers.

To avoid multiple reporting for certain private funds, the SEC will permit a sub-adviser to exclude private funds that are the subject of reporting by another adviser on Schedule D and will permit an adviser sponsoring a master-feeder arrangement to complete a single Schedule D for the master fund and its feeders if the information is substantially identical for all feeder funds (and if the feeder funds do not use a prime broker or custodian).

As amended, advisers must complete Section 7.B. of Schedule D for each private fund they (and not a related person) advise.  If a private fund has issued two or more series (or classes) of equity interests whose values are determined with respect to separate portfolios of securities and other assets, then each series (or class) should be regarded as a separate private fund if the separate classes are managed as if they are separate funds.

Note that the level of regulation applicable to Exempt Reporting Advisers is far less than that applicable to registered investment advisers.  Registered investment advisers are subject to annual reporting and updating of the complete Form ADV (all of Parts 1 and 2) which, in general, includes information similar to that included in a typical fund offering memorandum.  Registered investment advisers are also obligated to have a chief compliance officer who must be responsible for and monitor the firm's compliance with a multitude of requirements such as restrictions on trading activities of firm personnel, extensive books and records maintenance and monitoring, significant restrictions on marketing activities, custody of fund assets, disaster recovery policies, and others. In addition, registered investment advisers must adopt comprehensive compliance policies and a procedures manual, and a Code of Ethics that must be distributed to all firm employees, and must conduct a complete review of its compliance program on at least an annual basis.

What To Do Now?

In order to rely on the venture capital exemption, if they have not already done so, advisers need to immediately evaluate the terms of the partnership agreements and operating agreements for the funds they manage to determine whether such terms would disqualify the funds from being considered as venture capital funds for purposes of the Final Rule.  In addition, advisers should evaluate the investment strategies and holdings of the funds to ensure that they satisfy all elements of the venture capital fund definition in the Final Rule. 


Emerging venture managers often have an array of investment vehicles that precede the first committed venture fund that they manage.  For example, the manager may have previously been a fundless sponsor and may still be managing several single-investment vehicles.  The services offered by the adviser to these predecessor vehicles often carry on for years.  Any such adviser that believes that it is or will be rendering services to these predecessor vehicles after the July 21, 2011 implementation date should closely examine and determine whether the services provided to the predecessor vehicles are investment advisory services for compensation.  If they are, then the predecessor vehicles must be reviewed to determine if they are private funds that meet the venture capital fund definition or are grandfathered into that definition.  If they do not, the predecessor, carryover vehicles may likely preclude use of the Venture Capital Exemption available under the Advisers Act. 

1.         Rely on the venture capital fund exemption.  An adviser should analyze whether all its funds as of July 21, 2011 qualify under the Final Rule's definition of Venture Fund, including the conditions in the grandfathering provision.  It should consider if it can continue to operate all these funds with the Final Rule and, if so, prepare and file its Form ADV reports in a timely manner.  It needs to determine if new funds contemplated can comply with the Final Rule.  As noted above, if an adviser is able to fall within the Venture Funds exemption, it will not need to register as an investment adviser, but it will be subject to regulation under Dodd-Frank as an Exempt Reporting Adviser and is required to annually file and update certain parts of Form ADV Part 1. The first filing must be made between January 1 and March 30, 2012.

2.         Restructure to rely on the venture capital fund exemption or find another exemption or exclusion.  In the event that one or more existing funds do not now comply with the Final Rule or the adviser is otherwise engaged in activities which caused it to be an investment adviser but allowed it to rely upon the Private Adviser Exemption, that exemption is gone effective July 21, 2011.  The following summarizes some of the provisions that a venture capital fund may want to include in its partnership agreement or operating agreement (and, for the borrowing limitation, potentially in its loan agreements) as a result of the Final Rule.  The failure to include the provisions is not fatal to the ability to claim the venture capital exemption so long as the fund operates as if they were included.

  • Restrictions on Non-Qualifying Investments.  The fund must limit its investments in non-qualifying investments such that, immediately after the acquisition of any asset (other than qualifying investments or short-term holdings), no more than 20% of the fund's capital commitments is invested in non-qualifying investments.
  • Limitations on Borrowing.  The fund must limit its borrowings that remain outstanding for more than 120 days (including guarantees of a qualifying portfolio company's obligations) to no more than 15% of the fund's total capital contributions and uncalled capital commitments.
    • Redemption Rights.  Investors in the fund must have no redemption rights except in "extraordinary circumstances" (such as changes in law or in the event of a merger).  However, the fund can provide investors the right to be excluded from particular investments due to regulatory or other legal requirements.

Dodd-Frank did not repeal other exemptions from the definition of investment adviser in the Adviser Act.  Also, Dodd-Frank created two new federal exemptions (for (i) foreign private advisers and (ii) private fund advisers with less than $150 million in assets under management) and one new exclusion (for family offices). 

3.         Register as an investment adviser with the SEC effective by March 30, 2012.  An adviser that is no longer able rely on the Venture Capital Fund Exemption because it is providing investment advice to clients other than venture capital funds is required to register prior to advising those other funds unless another exemption is available.  If an investment adviser does not fall within the Venture Fund exemption or is not otherwise exempt from registration but is an investment adviser which previously relied upon the Private Adviser Exemption, then the date for registration as a registered investment adviser is extended to March 30, 2012.  The SEC suggests that advisers submit their Form ADV filings by February 14, 2012 to ensure registration by the deadline.

This article is published for general information, not to provide specific legal advice.  The application of any matter discussed in this article to anyone's particular situation requires knowledge and analysis by a lawyer of the specific facts involved.

Copyright 2013 Fairfield and Woods, P.C., ALL RIGHTS RESERVED.

Comments or inquiries may be directed to John A. Eckstein, 303.894.4448, or Gil B. Selinger, 303.894.4478.


[1] Under Section 204(a) of the Advisers Act, the SEC has the authority to require an investment adviser to maintain records and provide reports, as well as the authority to examine such adviser's records, unless the adviser is "specifically exempted" from the requirement to register pursuant to Section 203(b) of the Advisers Act.  Investment advisers that are exempt from registration in reliance on other sections of the Advisers Act (such as Sections 203(1) for Venture Capital Fund advisers) are not "specifically exempted" under Dodd-Frank from the requirement to register pursuant to Section 203(b); thus the SEC has authority under Section 204(a) of the Advisers Act to require advisers to Venture Funds to maintain records and provide reports and has authority to examine such advisers' records.  Although SEC Chair Mary Shapiro said in a prepared statement at the time of the Release of the Final Rule that the SEC did not plan to examine Venture Funds advisers on a routine basis, we highly recommend being prepared at all times for such an examination.  In footnote 163 in the Release, the SEC indicates that it will propose even more recordkeeping and compliance requirements for private advisers in the future.  Unfortunately, the SEC has not yet even hinted at the records to be kept for examination purposes. 

[2] See Fairfield and Woods, P.C., "SEC Proposes Definition of 'Venture Capital Fund' for Exemptions from Investment Advisers Act Registration and Outlines Reporting Obligations" (November 27, 2010), available at

[3] See footnote 2 above.

[4] See "Implementing Rules' Adviser Reporting Requirements Regarding Private Funds" below for a discussion of the changes to Item 7.B and its related Schedule D.

[5] To the extent that an adviser files on behalf of multiple related entities information regarding the private funds advised by those entities will be incorporated into the response to Item 7.B.