IM Guidance Update
 

Dec ember 2013 | No. 2013-13 

Guidance on the exemption for advisers to venture capital funds 

The Division of Investment Management (the “Division”) receives inquiries regarding 

the application of the exemption from investment adviser registration available to an 

investment adviser that advises solely one or more “venture capital funds” as defined in 

Rule 203(l)-1 of the Advisers Act (the “VC Exemption”).1

 To qualify as a “venture capital 

fund” the fund must be a “private fund”2 that represents to investors that it pursues a 

venture capital strategy; does not provide an investor with redemption rights other than 

in extraordinary circumstances; holds no more than 20% of the amount of the fund’s 

aggregate capital contributions and uncalled capital commitments in non-“qualifying 

investments”3 (excluding cash and certain short-term holdings); does not borrow or 

otherwise incur leverage in excess of 15% of the fund’s aggregate capital contributions 

and uncalled capital commitments, and then only on a short-term basis; and is not 

registered under the Investment Company Act of 1940 and has not elected to be 

treated as a business development company.4 

The five scenarios below are illustrative of the inquiries the Division is receiving with 

respect to the VC Exemption. Each involves situations where advisers have asked 

whether the fund structures or actions described below would jeopardize their ability 

to rely on the VC Exemption. The Division’s response follows each scenario. 

1)	 Scenario: Venture capital funds frequently hold their portfolio company investments 

through an intermediate holding company. Recognizing this, the Commission stated 

that, for purposes of the definition of a qualifying portfolio company, a fund may 

disregard an intermediate holding company formed solely for tax, legal or regulatory 

reasons to hold the fund’s investment in a qualifying portfolio company so long as 

such intermediate holding company is wholly owned by the fund.5 Venture capital 

advisers may have multiple private funds participating in any given portfolio company investment. For example, two venture capital funds with the same adviser 

(or advisers that are “related persons”6) may each invest in the same portfolio company. They may do so through a single intermediate holding company that is not 

wholly owned by either of the funds, but rather is wholly owned by the two funds 

collectively. Advisers have asked whether the Commission’s statement concerning 

US Securities and Exchange Commission 

Division of Investment Management 
im Guidance update 2 

intermediate holding companies being “wholly owned” by a venture capital fund 

means that venture capital funds with the same adviser (or advisers that are related 

persons) may not jointly own a single intermediate holding company to invest in a 

portfolio company if they wish to disregard such entity for VC Exemption purposes. 

Response: The Division would not object if an intermediate holding company is 

wholly owned collectively by more than one venture capital fund advised by the 

same investment adviser (or its related persons). 

2)	 Scenario: Venture capital funds may have investors with varying tax, legal or regulatory concerns that lead their advisers to structure the funds in a way that addresses 

these concerns. The adviser will often accommodate U.S. tax-exempt and non-U.S. 

investors by forming an alternative investment vehicle (“AIV”) that is separate from 

the venture capital fund and that will elect to be taxed as a corporation. The U.S. 

tax-exempt and non-U.S. investors invest directly into this AIV which is controlled 

and managed by the adviser or a related person and whose sole purpose is to 

invest in the venture capital fund. Because the AIV does not invest in “qualifying 

investments” and would therefore technically be holding more than 20% of the 

amount of the fund’s aggregated capital contributions and uncalled capital commitments in non-“qualifying investments,” advisers using this structure have asked the 

Division whether this structure disqualifies them from relying on the VC Exemption. 

Response: The Division would not object if an adviser relying on the VC Exemption 

disregards AIVs when determining whether it can meet the requirements of the VC 

Exemption provided that the AIV is formed solely to address investors’ tax, legal 

or regulatory concerns and such AIV is not intended to circumvent the VC Exemption’s general limitation on investing in other investment vehicles. 

3)	 Scenario: During the fundraising process for a prospective venture capital fund, the 

fund’s investment adviser may identify an investment opportunity in a qualifying 

portfolio company that the adviser would like the fund to invest in, but such fund 

is not yet able to make investments. Rather than potentially missing these investment opportunities because the fund is unable to make investments, the adviser 

may effect the purchase of such an investment and then transfer the securities of 

the investment to the venture capital fund (a “Warehoused Investment”) upon the 

fund’s closing. Advisers have asked whether this arrangement would be deemed a 

non- “qualifying investment” because the equity securities of the portfolio company 

would not be acquired directly from the qualifying portfolio company. 

Response: The Division would not object to an adviser treating a Warehoused Investment as if it were acquired directly from the qualifying portfolio company for purposes of the definition of “venture capital fund” under Rule 203(l)-1 of the Advisers 

Act provided that: (i) the Warehoused Investment is initially acquired by the adviser 
im Guidance update 3 

(or a person wholly owned and controlled by the adviser) directly from a qualifying 

portfolio company solely for the purpose of acquiring the investment for a prospective venture capital fund that is actively fundraising; and (ii) the terms of the Warehoused Investment are fully disclosed to each investor in the venture capital fund 

prior to each investor committing to invest in the fund.7 

4)	 Scenario: An adviser may establish a venture capital fund (“Main Fund”) and one or 

more private funds to invest in parallel with the Main Fund (“Side Funds”). In certain 

cases the adviser will close the Main Fund and form a Side Fund(s) in the months 

that follow, possibly after the Main Fund has made one or more portfolio company 

investments. The constituent documents of the Main Fund and any Side Fund(s) 

(e.g., the private placement memorandum and limited partnership agreement) typically provide that, in the event the Main Fund has made portfolio company investments before any Side Fund(s) has closed, the portfolio company securities will be 

transferred to the Side Fund(s) so that each fund holds its pro rata share of portfolio company securities as if each fund had made the investment on the same day on 

the same terms. Advisers have asked if the Main Fund transfers portfolio securities 

to a Side Fund as described above, whether this arrangement would be deemed a 

non- “qualifying investment” for the Side Fund because the equity securities of the 

portfolio company that are transferred to the Side Fund would be acquired from 

the Main Fund and not directly from the qualifying portfolio company. 

Response: The Division would not object to an adviser treating the investment by 

the Side Fund as described above as if the Side Fund acquired the portfolio company securities directly from the qualifying portfolio company for purposes of the 

definition of “venture capital fund” under Rule 203(l)-1 of the Advisers Act so long 

as such transfer occurs within 12 months of the final closing of the Main Fund and 

the potential for this type of transfer is fully disclosed in the constituent documents 

of the Main Fund and any Side Fund(s).8 

5)	 Scenario: As a venture capital fund reaches the end of its term, the adviser sometimes determines to wind up the remaining affairs of the fund by causing the 

remaining portfolio securities of the fund to be transferred into a liquidating trust 

for which the adviser or an affiliate serves as the liquidating trustee. The possibility 

of a liquidating trust and its terms are disclosed in the venture capital fund’s constituent documents. The purpose of the liquidating trust is to act as a successor to 

the venture capital fund and liquidate the remaining assets of the fund. Advisers 

have asked if the liquidating trust obtains its securities from the venture capital fund 

itself and not directly from a qualifying portfolio company whether this arrangement 

would be deemed a non-“qualifying investment.” 

Response: The Division would not object to the use of a liquidating trust by an 

investment adviser under the circumstances described above while relying on the 

VC Exemption. 
im Guidance update 4 

endnotes 

1	 See generally Section 203(l) of the Investment Advisers Act of 1940 (“Advisers 

Act”). 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) (“Release 3222”). 

2	 Section 202(a)(29) of the Advisers Act (definition of “private fund”). 

3	 A “qualifying investment” generally means an equity security issued by a qualifying 

portfolio company that has been acquired directly by the private fund from the 

qualifying portfolio company. A “qualifying portfolio company” means any company 

that: (i) at the time of any investment by the private fund, is not reporting or foreign 

traded and does not control, is not controlled by or under common control with 

another company, directly or indirectly, that is reporting or foreign traded; (ii) does 

not borrow or issue debt obligations in connection with the private fund’s investment 

in such company and distribute to the private fund the proceeds of such borrowing 

or issuance in exchange for the private fund’s investment; and (iii) is not an investment 

company, a private fund, an issuer that would be an investment company but for 

the exemption provided by Rule 3a-7 under the Investment Company Act of 1940, 

or a commodity pool. 

4	 Rule 203(l)-1 of the Advisers Act. 

5	 Release 3222 at 51-52. 

6	 As such term is defined in the Glossary to Form ADV. 

7	 With respect to full disclosure to investors, the Division typically would expect the 

terms to include the name of the company whose securities are being acquired, 

the cost at which the Warehoused Investment was acquired, how the price at which 

the fund will acquire the Warehoused Investment will be determined (e.g., fair market 

value or cost plus interest), including whether the price accounts for adverse events 

that have occurred since the adviser initially purchased the investment, and conflicts 

of interest arising as a result of the Warehoused Investment. In addition, advisers 

utilizing Warehoused Investments should generally consider their fiduciary obligations, Section 206(3) of the Advisers Act, and Rule 206(4)-8 of the Advisers Act. 

8	 Advisers again should consider their fiduciary obligations, Section 206(3) of the 

Advisers Act and Rule 206(4)-8 of the Advisers Act when engaging in these activities. 
i m G u i d a n c e u p d at e 5 

This IM Guidance Update summarizes the views of the Division of Investment Management 

regarding various requirements of the federal securities laws. Future changes in laws or 

regulations may supersede some of the discussion or issues raised herein. This IM Guidance 

Update is not a rule, regulation or statement of the Commission, and the Commission has 

neither approved nor disapproved of this IM Guidance Update. 

The Investment Management Division works to: 

s protect investors 

s promote informed investment decisions and 

s facilitate appropriate innovation in investment products and services 

through regulating the asset management industry. 

if you have any questions about this im Guidance update, please contact: 

Christopher McHugh 

Investment Adviser Regulation Office 

Phone: 202-551-6787 

Email: IArules@sec.gov