Implications for the venture ecosystem in the 118th Congress
From data privacy to digital assets, financial services will drive much of the policy debate in Congress, and capital formation will be a key focus. As the 118th Congress takes shape, the Carta Policy Team has identified the issues and stakeholders that are likely to influence capital formation in the coming months.
In this capital markets policy outlook, we’ll cover:
Key players and political dynamics in Congress
The 118th Congress brings a return to divided government, with Republicans controlling the House and Democrats leading the Senate. In a divided Congress, President Biden will have to find common ground with Republicans over the remaining two years of his first term to advance any legislative priorities. Razor-thin margins in both the House and Senate will give individual lawmakers considerable influence, and reaching consensus will be no easy feat.
Although each side will continue to draw contrasts over the next two years, bipartisan compromise is possible. Given the tightening economic conditions, policymakers across the spectrum will be focused on job creation and driving economic growth—which means proposals to bolster access to capital for small businesses could gain traction.
In Congress, financial services policy will be driven through the Senate Banking Committee (SBC) and the House Financial Services Committee (HFSC).
House Financial Services Committee
Rep. Patrick McHenry took the reins as HFSC Chairman under the new Republican House majority. McHenry has been a key advocate for the startup ecosystem and the fintech sector in particular. His financial legislative agenda will focus on promoting capital formation; ensuring that regulation does not stifle innovation, particularly in the fintech and digital asset space; and data privacy. McHenry is also expected to pursue aggressive oversight of the financial regulators; for capital markets, that is the SEC. Although parts of his agenda will strike partisan tones, namely around oversight and issues like ESG, McHenry has a reputation of building consensus, particularly around small business capital formation. We expect that approach to continue as he leads the Committee.
On the Democratic side, Rep. Maxine Waters will continue to lead the Democrats. Waters has been skeptical of private equity, the growth of the private markets, and their opacity. But she has worked closely with McHenry to advance a number of initiatives to improve access to capital for small businesses, including creating the qualifying venture capital fund exemption and improving crowdfunding.
Senate Banking Committee
Sen. Sherrod Brown will remain at the helm of the SBC, and his priorities will largely remain the same as last Congress: affordable housing, consumer and worker protection, and climate risk, as well as his recent focus on crypto regulation following the FTX collapse. Brown’s lack of focus on private markets or capital formation is not surprising. He has been critical of the private equity industry and the growth and opacity of the private markets more broadly, and has pushed for additional transparency measures for private companies and funds. Any capital formation proposals will be approached through that lens.
Sen. Tim Scott will lead SBC Republicans. Scott’s priorities will largely overlap with McHenry’s, with a focus on expanding access to capital and investment opportunities and financial inclusion. Scott and other SBC Republicans will also draw inspiration on the capital markets front from the JOBS 4.0 proposal outlined by former Sen. Pat Toomey last Congress (which Carta supported, and which aligns with our policy priorities).
The congressional capital formation agenda and implications for venture
Given these dynamics, much of the capital formation work in Congress will be driven by the House. A primary focus for Chairman McHenry will be capital formation, and he has outlined an agenda with a number of policies designed to expand access to capital for small businesses, increase investment opportunities, and ease the transition for companies to enter the public markets if it fits their business model.
Many of these provisions in McHenry’s agenda are in line with the JOBS Act 4.0 package that has been championed by Senate Republicans, and they support key principles underlying Scott’s Opportunity Agenda. The key going forward will be building bipartisan consensus around these overlapping interests.
Here are some of the key capital formation initiatives that could impact the venture community and their prospects:
Expanding access to capital for small businesses
Congress will look at venture capital reforms to expand capital access for small businesses access.
Increasing the size and investor limit for qualifying venture capital funds:Emerging fund managers play a key role supporting startups across the country, particularly for companies seeking smaller, early-stage financing. These smaller funds are more likely to participate in earlier rounds and invest in a more diverse pool of entrepreneurs located in geographic areas outside of traditional hubs. Currently, a venture capital fund can raise up to $10 million from 250 investors under section 3(c)(1) of the Investment Company Act. While the exemption was intended to allow smaller funds to reach more investors, in practice, the current parameters prevent a fund from covering its operational costs without charging outsized fees to investors. Proposals in the House and Senate last Congress would increase these caps and provide more utility to the provision.
Expanding the scope of qualifying venture investments:Currently, 80% of venture capital fund investments must be “qualifying” investments. Essentially, these are direct investments in private companies. The DEAL Act would expand this category to include investments in venture companies through secondary transactions and fund-of-fund investments. Permitting investments acquired through secondaries could help provide a significant source of liquidity for founders, employees, and early-stage investors to exit and redeploy capital, and provide an avenue for new investors to gain exposure to startups that have shown maturation and scale. Providing an avenue for larger venture funds to invest in small and emerging funds could help unlock a significant source of capital to benefit companies and funds in emerging entrepreneurial ecosystems. Legislation that helped expand what constitutes a “qualifying investment” passed the House last Congress, and we hope to build on this momentum.
Outlook: The SEC’s Small Business Advocate and Small Business Capital Formation Advisory Committee recommended increasing the 3(c)(1) caps and permitting fund-of-fund investments to be qualified investments as measures that can help improve capital access for underrepresented founders and investors in areas outside of traditional funding hubs—a message that resonates across both parties in Congress.
Especially as capital becomes harder to come by in the current economic climate, we think these provisions could gain traction despite increasing skepticism around the growth of the private markets.
Increasing investment and ownership opportunities
Congress will look to expand private market investment opportunities by expanding accredited investor criteria and permitting structured access to private market investments through funds:
Modernizing the accredited investor definition: Generally, an individual must be an accredited investor to access private market investment opportunities. The standard determines access primarily based on personal wealth and income. As a result, private market investment opportunities are largely restricted to institutional or wealthy investors. As the private markets have eclipsed the public markets in both size and return, investment opportunities for everyday investors have decreased. Companies are also staying private longer, meaning most investors are precluded from investing in and profiting from growth-stage companies, where much of the potential return on investment exists.
We expect efforts to focus on expanding accreditation criteria through nonfinancial metrics, including through sophistication tests and permitting individuals to invest a portion of their income or net assets in private market securities (similar to crowdfunding investment limits) or gaining access through an investment professional (who is most likely accredited).
In addition to expanding nonfinancial metrics, we expect efforts to codify the existing financial thresholds. The House previously passed legislation to codify the current financial thresholds with near-unanimous support, but progressive posturing and widely expected SEC action to raise the current thresholds could tamp down Democrat support.
Permitting structured access to private market investments through funds and retirement vehicles:Another path to increasing access to private market investment opportunities is through professionally managed vehicles, including by broadening the ability of closed-end funds to invest in private companies and clarifying the ability for 401(k)s to invest in private funds and other alternative assets (like crypto). Giving retail investors access to private market investment opportunities through structured funds and vehicles provides a number of important protections, including portfolio diversification and management by sophisticated, regulated fund managers with fiduciary duties. While there is potential for bipartisan support, recent collapses and volatility in the crypto markets and diligence concerns could jeopardize these efforts, particularly with respect to retirement.
Outlook: Lawmakers in both parties generally agree that financial metrics do not necessarily equate with financial sophistication, and limiting investment opportunities and the potential for diversification to the economically privileged is not a desired outcome. However, progressive concerns that investors are not adequately protected in the private markets—where there is less transparency, more illiquidity, and greater risk of fraud—will prevent any significant expansions in retail access to the private markets, especially as efforts are likely underway at the SEC to reduce access by raising the accredited investor wealth and income thresholds. Tailored legislative proposals that balance investor protection with investor access, such as through an investment professional or fund structure, may have a better chance of gaining traction with moderate Democrats who view equity ownership as a means to enhance wealth creation. We expect the debate over whether to expand or restrict investor accreditation (and how to do it) to continue, and for the accredited investor definition to become a bargaining chip in capital markets policymaking.
Potential for bipartisan capital market legislation
Razor-thin majorities and deep partisan divides will make legislating difficult this Congress. Increasing progressive skepticism of the private markets means a comprehensive legislative package such as the JOBS Act is unlikely, particularly with Chairman Brown at the helm in the Senate. More likely, progressives will seek to impede proposals that might bolster the private markets, especially if they are contrary to efforts underway at the SEC, whose agenda aims to rein in the private markets rather than expand them.
Nevertheless, individual provisions could move or be attached to must-past legislative proposals as part of broader negotiations. Democrats, who are facing a challenging 2024 Senate map, will also be motivated to score legislative wins, particularly on economic issues. Helping small businesses gain access to capital in a contracting economy will be politically advantageous. Many of the proposals outlined stem from recommendations from the work of the SEC’s Small Business Advocate and related advisory committee, whose recommendations often serve as the basis for bipartisan action.
Even if these policies are not enacted, bipartisan unity could push the SEC to moderate some of its proposals expected to make private market capital formation more challenging.
Regulatory agenda and congressional oversight
Despite potential areas of bipartisan interest, the challenging legislative environment will result in the regulatory agencies (in this case, the SEC) driving policy through rulemaking and enforcement initiatives.
SEC Chair Gary Gensler has embarked on an ambitious regulatory agenda, which includes a number of items aimed at bringing more transparency to the private markets. If implemented, these policy changes would have significant impacts on the venture ecosystem, making private markets less accessible for founders and investors. With a 3-2 majority, Gensler will most likely have the support necessary to advance these efforts.
SEC private market agenda
Specific private market reforms on the SEC’s agenda include:
Regulation D: The SEC is expected to consider changes to Regulation D, the predominant way private funds and companies raise money from investors. Potential changes could include conditioning the use of the exemption on a Form D filing, requiring pre-filing or closing amendments, and expanding the information collected on both Form D and on an ongoing basis. Depending on the scope of the proposal, these changes could create significant organizational costs that would disproportionately affect small and emerging managers and founders seeking to raise private capital under Regulation D.
Accredited investor: The Commission is expected to consider raising the financial thresholds to qualify as an accredited investor, which would limit investor access to the private markets. Higher financial thresholds will likely have a disproportionate impact on lower-cost regions that often lack access to traditional capital-raising networks.
12(g) holders of record: The SEC is expected to consider changes that could push more private companies into the public market by amending how “holders of record” are counted under Section 12(g) of the Securities and Exchange Act. This could push larger private companies into the public reporting space and impact the use of special purpose vehicles (SPVs) and other pooled investment structures.
Private fund advisers: The SEC is expected to finalize its private fund advisers rule proposal, which would fundamentally change how the private fund industry operates and is regulated. These rules would impose a number of new obligations on SEC-registered private fund advisers and prohibit all private fund advisers—including those in venture capital—from engaging in certain activities, such as the use of side letters or indemnification for simple negligence (a significant departure from common industry practice). Carta submitted a comment letter highlighting our concerns about the potential negative impacts the proposal could have on small and emerging fund managers.
As mentioned above, a large focus of the HFSC under McHenry’s leadership will be congressional oversight of regulatory agencies: The SEC and Chair Gensler are in the crosshairs. Republicans will not be able to stop the administration and regulators from moving forward on their respective agendas, but aggressive oversight could slow agency efforts, as responding to correspondence, investigations, and hearings takes time and diverts agency resources—and subpoena power gives these efforts teeth. Congressional oversight could also help bolster potential legal challenges, as the judicial branch has increased its scrutiny of agencies acting without explicit congressional authority. McHenry has started laying that groundwork for oversight with inquiries concerning the SEC’s rulemaking process and authority.
While oversight will largely be driven by Republicans, we have started to see moderate Democrats push back on the SEC. The SEC’s comment process under Gensler has been a source of bipartisan concern, not only because of tighter public comment windows, but also due to the complex and overlapping nature of some of the rulemaking proposals. Congressional pressure has been successful in delaying the SEC from finalizing some of its key priorities, including the private fund adviser proposal. While Chair Gensler is expected to push forward with his agenda (and will be under pressure from progressives to do so), bipartisan pushback could make it more uncomfortable to do so and help influence the contours of more controversial proposals.
Proactive engagement with policymakers will be critical to making progress on policies to bolster the venture ecosystem, including broadening access to capital and increasing investment and ownership opportunities in the private markets. Engagement will also be critical to defend against anticipated SEC actions that could make private markets less accessible for founders and investors. There is opportunity here, and the Carta Policy Team will be working with our coalition partners on this front bolster small business capital formation.