Those of you who work with investment funds will agree with me that this news is worth a separate blog posting. The Economic Growth, Regulatory Relief and Consumer Protection Act (the "Act") became law on May 24th, 2018. The Act significantly amends the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. There are many many changes to discuss, but my blog post will focus on just one change that is of importance to our private fund clients: venture capital funds with less than $10 million in capital commitments can have up to 250 investors and still rely on the exemption from the definition of "investment company" found in Section 3(c)(1) of the Investment Company Act.
Just to be clear, the old version of Section 3(c)(1) said that "any issuer whose outstanding securities are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of securities" would not be an "investment company" under the Investment Company Act.
Although simple on its face, the exemption actually contains a quite complicated method of calculating beneficial owners of securities, requiring to "look through" the record ownership of each potential purchaser. Also, all investors had (and still have) to be "accredited investors" under the Securities Act.
The new Section 3(c)(1) adds "(or, in the case of a qualifying venture capital fund, 250 persons)" after the words "one hundred persons" and at the end the following: "The term "qualifying venture capital fund" means a venture capital fund that has not more than $10,000,000 in aggregate capital contributions and uncalled committed capital ...".
This is an important change. For years, in order to be exempt from the provisions of the Investment Company Act, private funds relied on one of two available exemptions: Section 3(c)(1) that allowed only up to 100 "accredited investors" or Section 3(c)(7) that allows for unlimited number of "qualified purchasers", which is a much higher standard than "accredited investors". Under Section 2(a)(51) of the Investment Company Act, a "qualified purchaser" is, among others, a person with at least $5 million in investments, a company with at least $5 million in investments owned by close family members, or a company that has at least $25 million of investments. Given that the "qualified purchaser" is a much higher standard to meet, the private funds were typically constrained by the 100 "accredited investors" limitation in Section 3(c)(1).
The increased limit allows funds to have more investors, which means that the venture capital funds can now lower the minimum subscription amounts. This would attract more investors, and therefore facilitate the capital raising process.
However, note that this change applies only to venture capital funds, which is not a defined term in the Investment Company Act. However, a definition of a "venture capital fund" can be found in Rule 203(l)-1 promulgated by the SEC under the Investment Advisers Act. Is this the definition that should be used for the purposes of Section 3(c)(1) of the Investment Company Act? Does it mean that hedge funds that are private funds relying on the 3(c)(1) exemption are still limited to 100 investors?
Although some unanswered questions remain, I generally welcome this change because it aims to facilitate capital raising on the part of the VC funds, and consequently, by start-ups.
This article is not legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga. Ms. Shulga is the co-founder of Ross & Shulga PLLC, a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of corporate and securities law. She is also a member of Wall Street Blockchain Alliance.
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