Policy

How are venture capital funds regulated?

December 15, 2022
Holli Heiles Pandol

Venture capital funds are regulated by a series of federal securities laws and regulations that guide how VCs can raise money, set up their funds, and advertise services to investors. The Securities and Exchange Commission (SEC) has authority over private funds, including venture capital funds.

As a fund manager, understanding these laws and regulations apply to you and your fund will help you remain compliant, which builds investor confidence and helps you avoid potential regulatory enforcement actions (and related penalties) that could cause your firm reputational or financial harm.  

Important note: While we’re here to help you understand how venture capital funds are regulated, we aren’t giving legal advice. Talk to your fund’s legal counsel to understand how regulations will affect you and your fund.

Venture capital fund structures can be complex. How a fund is regulated can depend on how it’s organized, who’s managing it, the size of the fund, the fund’s investor composition, and other factors. 

Securities laws and regulations apply to venture capital at three levels:

  • The fund and its characteristics
  • The fund manager
  • The fundraising process

Fund regulations 

Funds are pooled investment vehicles that are raised and allocated according to a strategy outlined by the fund manager. Investors (also called limited partners or LPs) make decisions about which funds to invest in based on that strategy

What is a venture capital fund?

A fund meets the definition of a venture capital fund under the Investment Advisers Act of 1940 (Advisers Act) if it:

  • Does not invest more than 20% of the fund’s committed capital in non-qualifying investments, such as debt, secondaries, public issuances, fund-of-fund investments, or digital assets
  • Restricts borrowing and all other leverage to 15% of the fund size, and repays any leveraged debts within 120 days
  • Limits LP redemption rights (their ability to cash out of the fund) to “extraordinary circumstances”
  • Represents to investors and potential investors that it pursues a venture capital strategy

Venture fund strategies can include characteristics such as industry and stage of investment. While there are exceptions, the typical lifecycle of a venture fund (the total period the fund will hold investment assets) is 10 years. 

SEC-registered investment companies

The Investment Company Act of 1940 requires funds such as mutual funds and closed-end funds to register with the SEC as investment companies. SEC-registered investment companies can take investment capital from the general public. They also have significant compliance and disclosure obligations.  

Most venture capital funds, however, are private funds that qualify for exemption from registration under the Investment Company Act. 

Private funds 

Private funds—including venture capital, private equity, and hedge funds—can avoid SEC registration by meeting the conditions for exemption in Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. Exempt funds don’t face the same strict disclosure and compliance requirements as registered funds, but there are limitations around the number and types of investors that can participate. 

Private fund exemptions from registration under the Investment Company Act 

Exemption  Criteria
3(c)(1) 
  • Any fund not publicly offered with fewer than 100 beneficial owners who are all accredited investors
  • Qualifying venture capital funds managing less than $10M with fewer than 250 beneficial owners
3(c)(7)
  • Any fund not publicly offered whose investors are qualified purchasers.
  • The fund is limited to 1,999 investors to avoid SEC registration under the Securities Exchange Act of 1934

3(c)(1) exemption

A private fund qualifies for the Section 3(c)(1) exemption if it does not publicly offer its securities, and if it is not owned by more than 100 investors—all of whom must qualify as accredited investors

While the 100-investor limit seems simple on its face, the SEC applies some rules to counting fund investors, outlined in section 3(c)(1) of the Investment Company Act. Understanding these rules can help you avoid exceeding the limit and being found noncompliant with the Investment Company Act.  

For example, entities that invest in a fund (such as other private funds) are generally counted as one investor. But the SEC can “look through” an entity and count each of its owners separately if that entity owns more than 10% of the voting shares of your fund, or if it was formed for the purpose of investing in your fund. These provisions are meant to prevent fund managers from using pyramid structures to circumvent the 100-investor limit. 

Qualifying venture capital funds

Under Section 3(c)(1), a “qualifying venture capital fund” can have up to 250 investors if it manages $10 million or less and meets the requirements of a venture capital fund outlined above.

3(c)(7) exemption

The Section 3(c)(7) exemption is available if the fund does not publicly offer its securities and its investors are all qualified purchasers—a higher bar than the accredited investor standard. While there’s no limitation on the number of investors under Section 3(c)(7), the fund can have up to 1,999 investors before registration would be required under the Securities Exchange Act of 1934 (Exchange Act). 

Fund adviser regulations

Because most venture capital funds are exempt from SEC registration, regulatory oversight is applied to the fund manager, also known as the fund’s investment adviser.

The size of the adviser’s assets under management and its investment activities determine whether the SEC or a state regulator will regulate the fund:

Size of assets under management by the adviser Regulated by:
Small adviser (less than $25M) State regulator
Mid-size adviser ($25M–100M) State regulator or SEC
Large adviser (more than $100M) SEC

Before the passage of the Dodd-Frank Act, most private fund advisers were exempt from SEC registration. Now, private fund advisers have the same registration requirements and regulatory oversight as SEC-registered investment advisers unless they qualify as exempt reporting advisers.

Exempt reporting advisers

If you qualify as an exempt reporting adviser, you can avoid the regulatory requirements associated with being a registered fund adviser, which can be costly and time-consuming. 

You can qualify as an exempt reporting adviser if you meet one of the following exemptions:

  • Private fund adviser exemption: You solely advise private funds totaling less than $150 million in assets under management
  • Venture capital adviser exemption: You solely advise venture capital funds (with no asset limit) 

Qualifying for either the private fund adviser exemption or the venture capital adviser exemption doesn’t mean you’re exempt from regulation. Exempt reporting advisers are still subject to certain reporting requirements, including completing certain portions of Form ADV, which contains information about the fund manager and its business operations. Information reported on Form ADV is publicly available.

General anti-fraud provisions of federal securities laws also apply to advisers (as well as the funds), regardless of registration status. The Exchange Act, the Advisers Act, and anti-money laundering and know-your-customer (AML/KYC) regulations also apply to exempt reporting advisers. Finally, even exempt reporting advisers are also subject to examination by the SEC and state regulators. 

SEC-registered private fund advisers

SEC-registered investment advisers are required to comply with all the requirements under the Advisers Act and related rules. SEC-registered private fund advisers with over $150 million in assets under management also have to file Form PF with the SEC; it provides information about the fund’s size, leverage, liquidity, and investors. Unlike Form ADV, the information of Form PF isn’t made public; it’s used by the SEC to monitor systemic risk.

In 2022, the SEC proposed amendments to Form PF that would expand reporting requirements for private fund advisers. The proposed changes could significantly increase compliance costs for private funds. (For updates, subscribe to Carta’s weekly policy newsletter.)

Fundraising regulations

Private funds, including venture capital funds, can’t offer their securities to the general public. Instead, they raise capital through an exempt offering framework. The most commonly used framework is provided by Regulation D.

Regulation D

Regulation D outlines rules funds or companies can follow to sell their securities without registering the offering with the SEC. Most private capital is raised under the framework outlined in Rule 506 of Regulation D, either through Rule 506(b) or Rule 506(c)

Rule 506 of Regulation D is a safe harbor. If a fund complies with the rule, the SEC considers it to be making a private placement and not a public offering, which means the fund can avoid the costs associated with SEC registration and related reporting requirements. 

Venture capital funds are able to raise an unlimited amount of capital from accredited investors under both provisions of Rule 506, though the fund will still have to abide by the investor limits in 3(c)(1) and 3(c)(7). 

Under Rule 506(b), funds aren’t allowed to publicly market or solicit their fundraising efforts outside of previously established personal and professional networks. But investors in 506(b) funds can self-certify as accredited investors. 

Under Rule 506(c), fund managers are able to publicly advertise their funds, but they must take reasonable steps to verify that investors are accredited.

Rule 506(b) is still the predominant framework used to raise private capital because it can be burdensome and costly to verify that investors are accredited.  

Funds raising capital under Regulation D have to file Form D, which asks for information about the entity raising money and the size of the sale. The fund must submit Form D to the SEC within 15 days of the first sale or risk being locked out of future Regulation D offerings.

→ Learn more about Rules 506(b) and 506(c) before you launch your fund. 

Blue sky laws

Blue sky laws govern the offering and sales of securities within a state. Federal securities laws preempt blue sky laws in many cases. For example, Rules 506(b) and 506(c) provide issuers safe harbor from state blue sky laws. However, state anti-fraud laws and notice filing requirements may still apply, depending on the type of offering and where investors are located. 

Regulation S

Regulation S allows companies to sell shares to investors outside the U.S. without registering the offering with the SEC. Unlike Regulation D, investors outside the U.S. don’t need to meet accredited investor standards. However, the SEC has additional rules for offerings to qualify for exemption under Regulation S.

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