Who is allowed to be a venture capitalist?

Over the past decade, group investing has risen in popularity, typically occurring in the form of sponsor-led investments. Deal sponsors (typically referred to as GPs in the context of a fund, or deal leads in the context of an SPV) are responsible for obtaining an allocation, running diligence on a deal, and garnering interest in an investment. A deal sponsor leads investments on behalf of passive co-investors, who decide to invest in deals on the recommendation of the sponsor and are not actively involved in the vetting and sharing of the investment opportunity. Deal sponsors are typically compensated for their involvement via carried interest – upside in the investment after investors in the deal are returned the amount they originally invested. This structure results in the vehicle being considered an investment fund, and the deal sponsor an investment adviser. While these terms may sound scary, there are certain exemptions for VC investors that make it possible for almost anyone to syndicate VC investments.

If VCs are regulated, how can almost anyone be a VC?

The regulation governing investment funds (including SPVs) and the individuals that organize them is, at its core, the same regulation that governs private equity, hedge, and real estate funds. But funds and fund advisers (or sponsors) who pursue a “qualifying VC strategy” benefit from certain regulatory exemptions. As we’ve previously highlighted, a “qualifying VC strategy” means that more than 80% of the capital that it raises must be used to acquire equity securities from a private company directly.

The federal compliance requirements for funds that meet this qualification are:

A Form D, which is a very simple form that has to be filed with the SEC anytime a company raises money (since the fund is a company), and
A short-form version of a Form ADV, which is a form that an investment adviser should file with FINRA and the SEC within sixty days of first engaging in advisory activity – e.g. structuring an SPV where the adviser receives carried interest as compensation (note, an adviser to “qualifying VC” funds that registers with FINRA & the SEC using the short-form Form ADV is referred to as an “Exempt Reporting Adviser,” or ERA).

These requirements apply to every VC SPV and fund out there, regardless of whether the investments are structured through a law firm, a fund admin, or SPV platform. Advisers to qualified VC funds are generally permitted to accept “accredited investors” as investors in addition to “qualified clients” or “qualified purchasers”, which each present significantly higher wealth thresholds for participation.

Wait, I thought you said VCs are exempt from requirements?

While the above requirements for a qualified VC fund may seem onerous, they’re relatively straightforward as compared to those that apply to other types of (non-qualifying) private funds. Private (non-VC) funds include those that purchase shares in a secondary transaction, funds that syndicate debt investments (other than convertible notes), funds that acquire cryptocurrency assets, or funds that invest in other SPVs or funds. Any private fund that pursues a non-qualifying VC strategy opens Pandora’s box of state regulations. Such regulations create additional restrictions and requirements for funds and advisers; for example, they may be limited to accepting capital only from “qualified clients” or “qualified purchasers,” and require audited financials, elevated compliance obligations, and the completion of lengthy forms.

These onerous requirements are triggered at a certain threshold of assets under management (AUM). An adviser that syndicates any non-VC private fund (even a single SPV), and manages a total of over $150M in assets (based on current value), is required to register with FINRA and the SEC as a registered investment adviser (RIA). Registering as an RIA is no simple feat, and requires a long-form registration on Form ADV, adherence to strict fiduciary duties, the appointment of a Chief Compliance Officer, maintenance of books and records related to market transactions, audited financial statements, a formal custodian for fund securities, and notably, limits the adviser to raise capital from qualified clients (individuals with net worth over $2.2M). In addition to these SEC federal requirements, they also may be subject to additional restrictions and requirements under their individual state law. As mentioned, this is potentially in addition to more restrictive and onerous state law.

What does it all mean?

So, that was all pretty complicated. Let’s go through a few specific examples of investment vehicles and identify whether they would qualify for the VC fund exemption.

Example 1: Preferred or common stock purchased directly from a private company

Qualifying VC? Yes
Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 2: SAFE issued by a private company directly

Qualifying VC? Yes

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 3: Convertible Promissory Note issued by a private company directly

Qualifying VC? Yes

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 4: Promissory Note not convertible for company equity issued by a company directly

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 5: YC SAFE and a Warrant to acquire governance tokens (a “Token Warrant”), all issued by a private company directly

Qualifying VC? Yes, but only if the SAFE’s value at the time of every fund investment is >80% of the value of fund assets (all cash committed and contributed to the SPV/fund)

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 6: Preferred/Common Stock and a Token Warrant, all issued by a private company directly

Qualifying VC? Yes, but only if the Preferred/Common Stock’s value at the time of every fund investment is >80% of the value of fund assets (all cash committed and contributed to the SPV/fund)
Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 7: Common Stock or Preferred Stock acquired from anyone other than a private company directly (e.g. acquired from a founder, another investor, etc.); typically referred to as a “secondary” transaction

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 8: SPV interests or another Fund’s LP interests

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 9: Any assets other than equity securities issued by a company directly that: (a) are >80% of the SPV/fund’s total assets and (b) that also results in the total value of funds/SPVs managed by the sponsor exceeding $150M.

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? RIA

TLDR: as long as at least 80% of the cash committed across all of the SPVs or funds you organize is used to purchase equity securities from a company directly, then you can generally raise capital from accredited investors and avoid limits around your AUM.

Want to learn more about the VC fund exemption? Check out this article.

Over the past decade, group investing has risen in popularity, typically occurring in the form of sponsor-led investments. Deal sponsors (typically referred to as GPs in the context of a fund, or deal leads in the context of an SPV) are responsible for obtaining an allocation, running diligence on a deal, and garnering interest in an investment. A deal sponsor leads investments on behalf of passive co-investors, who decide to invest in deals on the recommendation of the sponsor and are not actively involved in the vetting and sharing of the investment opportunity. Deal sponsors are typically compensated for their involvement via carried interest – upside in the investment after investors in the deal are returned the amount they originally invested. This structure results in the vehicle being considered an investment fund, and the deal sponsor an investment adviser. While these terms may sound scary, there are certain exemptions for VC investors that make it possible for almost anyone to syndicate VC investments.

If VCs are regulated, how can almost anyone be a VC?

The regulation governing investment funds (including SPVs) and the individuals that organize them is, at its core, the same regulation that governs private equity, hedge, and real estate funds. But funds and fund advisers (or sponsors) who pursue a “qualifying VC strategy” benefit from certain regulatory exemptions. As we’ve previously highlighted, a “qualifying VC strategy” means that more than 80% of the capital that it raises must be used to acquire equity securities from a private company directly.

The federal compliance requirements for funds that meet this qualification are:

A Form D, which is a very simple form that has to be filed with the SEC anytime a company raises money (since the fund is a company), and
A short-form version of a Form ADV, which is a form that an investment adviser should file with FINRA and the SEC within sixty days of first engaging in advisory activity – e.g. structuring an SPV where the adviser receives carried interest as compensation (note, an adviser to “qualifying VC” funds that registers with FINRA & the SEC using the short-form Form ADV is referred to as an “Exempt Reporting Adviser,” or ERA).

These requirements apply to every VC SPV and fund out there, regardless of whether the investments are structured through a law firm, a fund admin, or SPV platform. Advisers to qualified VC funds are generally permitted to accept “accredited investors” as investors in addition to “qualified clients” or “qualified purchasers”, which each present significantly higher wealth thresholds for participation.

Wait, I thought you said VCs are exempt from requirements?

While the above requirements for a qualified VC fund may seem onerous, they’re relatively straightforward as compared to those that apply to other types of (non-qualifying) private funds. Private (non-VC) funds include those that purchase shares in a secondary transaction, funds that syndicate debt investments (other than convertible notes), funds that acquire cryptocurrency assets, or funds that invest in other SPVs or funds. Any private fund that pursues a non-qualifying VC strategy opens Pandora’s box of state regulations. Such regulations create additional restrictions and requirements for funds and advisers; for example, they may be limited to accepting capital only from “qualified clients” or “qualified purchasers,” and require audited financials, elevated compliance obligations, and the completion of lengthy forms.

These onerous requirements are triggered at a certain threshold of assets under management (AUM). An adviser that syndicates any non-VC private fund (even a single SPV), and manages a total of over $150M in assets (based on current value), is required to register with FINRA and the SEC as a registered investment adviser (RIA). Registering as an RIA is no simple feat, and requires a long-form registration on Form ADV, adherence to strict fiduciary duties, the appointment of a Chief Compliance Officer, maintenance of books and records related to market transactions, audited financial statements, a formal custodian for fund securities, and notably, limits the adviser to raise capital from qualified clients (individuals with net worth over $2.2M). In addition to these SEC federal requirements, they also may be subject to additional restrictions and requirements under their individual state law. As mentioned, this is potentially in addition to more restrictive and onerous state law.

What does it all mean?

So, that was all pretty complicated. Let’s go through a few specific examples of investment vehicles and identify whether they would qualify for the VC fund exemption.

Example 1: Preferred or common stock purchased directly from a private company

Qualifying VC? Yes
Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 2: SAFE issued by a private company directly

Qualifying VC? Yes

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 3: Convertible Promissory Note issued by a private company directly

Qualifying VC? Yes

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 4: Promissory Note not convertible for company equity issued by a company directly

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 5: YC SAFE and a Warrant to acquire governance tokens (a “Token Warrant”), all issued by a private company directly

Qualifying VC? Yes, but only if the SAFE’s value at the time of every fund investment is >80% of the value of fund assets (all cash committed and contributed to the SPV/fund)

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 6: Preferred/Common Stock and a Token Warrant, all issued by a private company directly

Qualifying VC? Yes, but only if the Preferred/Common Stock’s value at the time of every fund investment is >80% of the value of fund assets (all cash committed and contributed to the SPV/fund)
Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 7: Common Stock or Preferred Stock acquired from anyone other than a private company directly (e.g. acquired from a founder, another investor, etc.); typically referred to as a “secondary” transaction

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 8: SPV interests or another Fund’s LP interests

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 9: Any assets other than equity securities issued by a company directly that: (a) are >80% of the SPV/fund’s total assets and (b) that also results in the total value of funds/SPVs managed by the sponsor exceeding $150M.

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? RIA

TLDR: as long as at least 80% of the cash committed across all of the SPVs or funds you organize is used to purchase equity securities from a company directly, then you can generally raise capital from accredited investors and avoid limits around your AUM.

Want to learn more about the VC fund exemption? Check out this article.

Over the past decade, group investing has risen in popularity, typically occurring in the form of sponsor-led investments. Deal sponsors (typically referred to as GPs in the context of a fund, or deal leads in the context of an SPV) are responsible for obtaining an allocation, running diligence on a deal, and garnering interest in an investment. A deal sponsor leads investments on behalf of passive co-investors, who decide to invest in deals on the recommendation of the sponsor and are not actively involved in the vetting and sharing of the investment opportunity. Deal sponsors are typically compensated for their involvement via carried interest – upside in the investment after investors in the deal are returned the amount they originally invested. This structure results in the vehicle being considered an investment fund, and the deal sponsor an investment adviser. While these terms may sound scary, there are certain exemptions for VC investors that make it possible for almost anyone to syndicate VC investments.

If VCs are regulated, how can almost anyone be a VC?

The regulation governing investment funds (including SPVs) and the individuals that organize them is, at its core, the same regulation that governs private equity, hedge, and real estate funds. But funds and fund advisers (or sponsors) who pursue a “qualifying VC strategy” benefit from certain regulatory exemptions. As we’ve previously highlighted, a “qualifying VC strategy” means that more than 80% of the capital that it raises must be used to acquire equity securities from a private company directly.

The federal compliance requirements for funds that meet this qualification are:

A Form D, which is a very simple form that has to be filed with the SEC anytime a company raises money (since the fund is a company), and
A short-form version of a Form ADV, which is a form that an investment adviser should file with FINRA and the SEC within sixty days of first engaging in advisory activity – e.g. structuring an SPV where the adviser receives carried interest as compensation (note, an adviser to “qualifying VC” funds that registers with FINRA & the SEC using the short-form Form ADV is referred to as an “Exempt Reporting Adviser,” or ERA).

These requirements apply to every VC SPV and fund out there, regardless of whether the investments are structured through a law firm, a fund admin, or SPV platform. Advisers to qualified VC funds are generally permitted to accept “accredited investors” as investors in addition to “qualified clients” or “qualified purchasers”, which each present significantly higher wealth thresholds for participation.

Wait, I thought you said VCs are exempt from requirements?

While the above requirements for a qualified VC fund may seem onerous, they’re relatively straightforward as compared to those that apply to other types of (non-qualifying) private funds. Private (non-VC) funds include those that purchase shares in a secondary transaction, funds that syndicate debt investments (other than convertible notes), funds that acquire cryptocurrency assets, or funds that invest in other SPVs or funds. Any private fund that pursues a non-qualifying VC strategy opens Pandora’s box of state regulations. Such regulations create additional restrictions and requirements for funds and advisers; for example, they may be limited to accepting capital only from “qualified clients” or “qualified purchasers,” and require audited financials, elevated compliance obligations, and the completion of lengthy forms.

These onerous requirements are triggered at a certain threshold of assets under management (AUM). An adviser that syndicates any non-VC private fund (even a single SPV), and manages a total of over $150M in assets (based on current value), is required to register with FINRA and the SEC as a registered investment adviser (RIA). Registering as an RIA is no simple feat, and requires a long-form registration on Form ADV, adherence to strict fiduciary duties, the appointment of a Chief Compliance Officer, maintenance of books and records related to market transactions, audited financial statements, a formal custodian for fund securities, and notably, limits the adviser to raise capital from qualified clients (individuals with net worth over $2.2M). In addition to these SEC federal requirements, they also may be subject to additional restrictions and requirements under their individual state law. As mentioned, this is potentially in addition to more restrictive and onerous state law.

What does it all mean?

So, that was all pretty complicated. Let’s go through a few specific examples of investment vehicles and identify whether they would qualify for the VC fund exemption.

Example 1: Preferred or common stock purchased directly from a private company

Qualifying VC? Yes
Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 2: SAFE issued by a private company directly

Qualifying VC? Yes

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 3: Convertible Promissory Note issued by a private company directly

Qualifying VC? Yes

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 4: Promissory Note not convertible for company equity issued by a company directly

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 5: YC SAFE and a Warrant to acquire governance tokens (a “Token Warrant”), all issued by a private company directly

Qualifying VC? Yes, but only if the SAFE’s value at the time of every fund investment is >80% of the value of fund assets (all cash committed and contributed to the SPV/fund)

Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 6: Preferred/Common Stock and a Token Warrant, all issued by a private company directly

Qualifying VC? Yes, but only if the Preferred/Common Stock’s value at the time of every fund investment is >80% of the value of fund assets (all cash committed and contributed to the SPV/fund)
Who can invest: Accredited Investors+
ERA or RIA? ERA

Example 7: Common Stock or Preferred Stock acquired from anyone other than a private company directly (e.g. acquired from a founder, another investor, etc.); typically referred to as a “secondary” transaction

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 8: SPV interests or another Fund’s LP interests

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? ERA until AUM exceeds $150M, then RIA

Example 9: Any assets other than equity securities issued by a company directly that: (a) are >80% of the SPV/fund’s total assets and (b) that also results in the total value of funds/SPVs managed by the sponsor exceeding $150M.

Qualifying VC? No

Who can invest: Qualified Clients+
ERA or RIA? RIA

TLDR: as long as at least 80% of the cash committed across all of the SPVs or funds you organize is used to purchase equity securities from a company directly, then you can generally raise capital from accredited investors and avoid limits around your AUM.

Want to learn more about the VC fund exemption? Check out this article.