Investment advisers to private funds are typically required to register with the SEC or state authorities unless they qualify for an exemption. For advisers focused on venture capital, the Venture Capital Fund Adviser Exemption is a highly attractive option.
Its primary appeal is the absence of a cap on assets under management (AUM). Unlike the general private fund adviser exemption, which is limited to advisers with less than $150 million in AUM, advisers who solely manage “venture capital funds” can rely on this exemption regardless of their AUM.
Why Use an Exemption from Registration?
Choosing to operate as an Exempt Reporting Adviser (ERA) rather than a fully registered investment adviser allows venture capital firms to avoid significant regulatory burdens. The benefits of avoiding full registration include not having to:
- Appoint a dedicated Chief Compliance Officer (CCO).
- File the full Form ADV, including Part 2A (the “Brochure”) and Form CRS.
- Create and enforce a detailed compliance manual and code of ethics.
- Obtain securities licenses for principals and representatives.
- Comply with restrictive advisory contract rules (e.g., performance-based compensation is generally permissible for ERAs).
- Adhere to the full scope of the SEC’s Custody Rule and Marketing Rule.
- Meet extensive record-keeping requirements.
- Undergo regular SEC examinations (while the SEC reserves the right to examine ERAs, it is rare in practice).
What is a “Venture Capital Fund”?
The exemption’s availability hinges on the precise definition of a “venture capital fund.” An adviser must solely advise funds that meet this definition.
Rule 203(l)-1 under the Investment Advisers Act defines a venture capital fund as any private fund that meets the following five criteria:
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Represents itself as a venture capital fund. The fund’s organizational and offering documents must clearly state that it pursues a venture capital strategy.
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Limits non-qualifying investments. No more than 20% of the fund’s capital contributions and uncalled committed capital can be invested in assets that are not “qualifying investments.” This 20% bucket provides flexibility for investments that fall outside the core VC strategy, such as buying shares from a founder on the secondary market or investing in another fund.
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Restricts leverage. The fund cannot borrow or incur leverage in excess of 15% of its aggregate capital, and any such borrowing must be for a non-renewable term of 120 days or less. An exception exists for guaranteeing the debt of a qualifying portfolio company.
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Prohibits redemption rights. The fund cannot grant investors the right to redeem or withdraw their capital, except in extraordinary circumstances. Pro-rata distributions to all investors are permitted.
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Is not a registered fund. The fund cannot be registered under the Investment Company Act of 1940 or be a business development company (BDC).
Key Definitions
Qualifying Investment
A “qualifying investment” is generally an equity security that the fund acquires directly from a “qualifying portfolio company.” This means that purchasing shares from a third party, such as a founder or another investor, does not count as a qualifying investment and must fit within the 20% basket.
Qualifying Portfolio Company
A “qualifying portfolio company” is an operating company that:
- Is not a public company (i.e., not subject to SEC reporting requirements).
- Does not use the fund’s investment proceeds to buy back its own securities.
- Is not itself an investment fund (e.g., another private fund or an investment company).
Requirements for Advisers Relying on the Exemption
While exempt from full registration, advisers relying on this exemption are known as Exempt Reporting Advisers (ERAs). They still have important compliance obligations:
- File a Truncated Form ADV: ERAs must file certain sections of Form ADV with the SEC and update it at least annually.
- Comply with Anti-Fraud Rules: The anti-fraud provisions of the Advisers Act still apply, making it illegal to mislead or defraud investors.
- Pay SEC and State Fees: Annual filing fees are required.
State vs. Federal Regulation
The VC Fund Adviser Exemption is a federal exemption from SEC registration. It is only available to advisers who are otherwise required to register with the SEC (typically those with $100M+ AUM) or are permitted to register.
If you are prohibited from registering with the SEC (generally because you have less than $100M AUM), you are subject to state regulation. You must look to the laws of your home state and any state where you have clients to find an applicable exemption.
For more information, see our guide on State-by-State Investment Adviser Exemptions.
What Other Federal Exemptions Are Available?
If the venture capital exemption doesn’t fit, advisers may consider other federal exemptions, such as:
- Private Fund Adviser Exemption: For advisers who only manage private funds and have less than $150 million in AUM.
- Foreign Private Adviser Exemption: For non-U.S. advisers with a limited connection to the United States.
