# Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2011-16118

## Record

- **Collection:** Federal Register
- **Document type:** Rule
- **Published:** July 6, 2011
- **Citation:** 76 FR 39645

## Text

SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. IA-3222; File No. S7-37-10]
RIN 3235-AK81
Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers

AGENCY:

Securities and Exchange Commission.

ACTION:

Final rule.

SUMMARY:

The Securities and Exchange Commission (the “Commission”) is adopting rules to implement new exemptions from the registration requirements of the Investment Advisers Act of 1940 for advisers to certain privately offered investment funds; these exemptions were enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). As required by Title IV of the Dodd-Frank Act—the Private Fund Investment Advisers Registration Act of 2010—the new rules define “venture capital fund” and provide an exemption from registration for advisers with less than $150 million in private fund assets under management in the United States. The new rules also clarify the meaning of certain terms included in a new exemption from registration for “foreign private advisers.”

DATES:

Effective Date:
July 21, 2011.

FOR FURTHER INFORMATION CONTACT:

Brian McLaughlin Johnson, Tram N. Nguyen or David A. Vaughan, at (202) 551-6787 or
IArules@sec.gov
, Division of Investment Management, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

The Commission is adopting rules 203(l)-1, 203(m)-1 and 202(a)(30)-1 (17 CFR 275.203(l)-1, 275.203(m)-1 and 275.202(a)(30)-1) under the Investment Advisers Act of 1940 (15 U.S.C. 80b) (the “Advisers Act”).
1

1
Unless otherwise noted, all references to rules under the Advisers Act will be to Title 17, Part 275 of the Code of Federal Regulations (17 CFR 275).

Table of Contents

I. Background

II. Discussion

A. Definition of Venture Capital Fund

1. Qualifying Investments

2. Short-Term Holdings

3. Qualifying Portfolio Company

4. Management Involvement

5. Limitation on Leverage

6. No Redemption Rights

7. Represents Itself as Pursuing a Venture Capital Strategy

8. Is a Private Fund

9. Application to Non-U.S. Advisers

10. Grandfathering Provision

B. Exemption for Investment Advisers Solely to Private Funds With Less Than $150 Million in Assets Under Management

1. Advises Solely Private Funds

2. Private Fund Assets

3. Assets Managed in the United States

4. United States Person

C. Foreign Private Advisers

1. Clients

2. Private Fund Investor

3. In the United States

4. Place of Business

5. Assets Under Management

D. Subadvisory Relationships and Advisory Affiliates

III. Certain Administrative Law Matters

IV. Paperwork Reduction Analysis

V. Cost-Benefit Analysis

VI. Regulatory Flexibility Certification

VII. Statutory Authority

Text of Rules

I. Background

On July 21, 2010, President Obama signed into law the Dodd-Frank Act,
2

which, among other things, repeals section 203(b)(3) of the Advisers Act.
3

Section 203(b)(3) exempted any investment adviser from registration if the investment adviser (i) had fewer than 15 clients in the preceding 12 months, (ii) did not hold itself out to the public as an investment adviser and (iii) did not act as an investment adviser to a registered investment company or a company that has elected to be a business development company (the “private adviser exemption”).
4

Advisers specifically exempt under section 203(b) are not subject to reporting or recordkeeping provisions under the Advisers Act, and are not subject to examination by our staff.
5

2
Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203, 124 Stat. 1376 (2010).

3
In this Release, when we refer to the “Advisers Act,” we refer to the Advisers Act as in effect on July 21, 2011.

4
15 U.S.C. 80b-3(b)(3) as in effect before July 21, 2011.

5
Under section 204(a) of the Advisers Act, the Commission has the authority to require an investment adviser to maintain records and provide reports, as well as the authority to examine such adviser's records, unless the adviser is “specifically exempted” from the requirement to register pursuant to section 203(b) of the Advisers Act. Investment advisers that are exempt from registration in reliance on other sections of the Advisers Act (such as sections 203(l) or 203(m) which we discuss below) are not “specifically exempted” from the requirement to register pursuant to section 203(b), and thus the Commission has authority under section 204(a) of the Advisers Act to require those advisers to maintain records and provide reports and has authority to examine such advisers' records.

The primary purpose of Congress in repealing section 203(b)(3) was to require advisers to “private funds” to register under the Advisers Act.
6

Private funds include hedge funds, private equity funds and other types of pooled investment vehicles that are excluded from the definition of “investment company” under the Investment Company Act of 1940
7

(“Investment Company Act”) by reason of section 3(c)(1) or 3(c)(7) of such Act.
8

Section 3(c)(1) is available to a fund that does not publicly offer the securities it issues
9

and has 100 or fewer beneficial owners of its outstanding securities.
10

A fund relying on section 3(c)(7) cannot publicly offer the securities it issues
11

and generally must limit the owners of its outstanding securities to “qualified purchasers.”
12

6

See
S. Rep. No. 111-176, at 71-3 (2010) (“S. Rep. No. 111-176”); H. Rep. No. 111-517, at 866 (2010) (“H. Rep. No. 111-517”). H. Rep. No. 111-517 contains the conference report accompanying the version of H.R. 4173 that was debated in conference. While the Senate voted to exempt private equity fund advisers in addition to venture capital fund advisers from the requirement to register under the Advisers Act, the Dodd-Frank Act exempts only venture capital fund advisers. Compare Restoring American Financial Stability Act of 2010, S. 3217, 111th Cong. § 408 (2010) (as passed by the Senate) with The Wall Street Reform and Consumer Protection Act of 2009, H.R. 4173, 111th Cong. (2009) (as passed by the House) (“H.R. 4173”)
and
Dodd-Frank Act (2010),
supra
note 2.

7
15 U.S.C. 80a.

8
Section 202(a)(29) of the Advisers Act defines the term “private fund” as “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for section 3(c)(1) or 3(c)(7) of that Act.”

9
Interests in a private fund may be offered pursuant to an exemption from registration under the Securities Act of 1933 (15 U.S.C. 77) (“Securities Act”). Notwithstanding these exemptions, the persons who market interests in a private fund may be subject to the registration requirements of section 15(a) under the Securities Exchange Act of 1934 (“Exchange Act”) (15 U.S.C. 78o(a)). The Exchange Act generally defines a “broker” as any person engaged in the business of effecting transactions in securities for the account of others. Section 3(a)(4)(A) of the Exchange Act (15 U.S.C. 78c(a)(4)(A)).
See also

Definition of Terms in and Specific Exemptions for Banks, Savings Associations, and Savings Banks Under Sections 3(a)(4) and 3(a)(5) of the Securities Exchange Act of 1934,
Exchange Act Release No. 44291 (May 11, 2001) [66 FR 27759 (May 18, 2001)], at n.124 (“Solicitation is one of the most relevant factors in determining whether a person is effecting transactions.”);
Political Contributions by Certain Investment Advisers,
Investment Advisers Act Release No. 3043 (July 1, 2010) [75 FR 41018 (July 14, 2010)], n.326 (“Pay to Play Release”).

10

See
section 3(c)(1) of the Investment Company Act (providing an exclusion from the definition of “investment company” for any “issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities.”).

11

See supra
note 9.

12

See
section 3(c)(7) of the Investment Company Act (providing an exclusion from the definition of

“investment company” for any “issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers, and which is not making and does not at that time propose to make a public offering of such securities.”). The term “qualified purchaser” is defined in section 2(a)(51) of the Investment Company Act.

Each private fund advised by an adviser has typically qualified as a single client for purposes of the private adviser exemption.
13

As a result, investment advisers could advise up to 14 private funds, regardless of the total number of investors investing in the funds or the amount of assets of the funds, without the need to register with us.
14

13

See
rule 203(b)(3)-1(a)(2) as in effect before July 21, 2011.

14

See
Staff Report to the United States Securities and Exchange Commission, Implications of the Growth of Hedge Funds, at 21 (2003),
http://www.sec.gov/news/studies/hedgefunds0903.pdf
(discussing section 203(b)(3) of the Advisers Act as in effect before July 21, 2011). Concern about this lack of Commission oversight led us to adopt a rule in 2004 extending registration to hedge fund advisers.
See

Registration Under the Advisers Act of Certain Hedge Fund Advisers,
Investment Advisers Act Release No. 2333 (Dec. 2, 2004) [69 FR 72054 (Dec. 10, 2004)] (“Hedge Fund Adviser Registration Release”). This rule was vacated by a Federal court in 2006.
Goldstein v. Securities and Exchange Commission,
451 F.3d 873 (D.C. Cir. 2006) (“Goldstein”).

In Title IV of the Dodd-Frank Act (“Title IV”), Congress generally extended Advisers Act registration to advisers to hedge funds and many other private funds by eliminating the private adviser exemption.
15

In addition to removing the broad exemption provided by section 203(b)(3), Congress amended the Advisers Act to create three more limited exemptions from registration under the Advisers Act.
16

These amendments become effective on July 21, 2011.
17

New section 203(l) of the Advisers Act provides that an investment adviser that solely advises venture capital funds is exempt from registration under the Advisers Act (the “venture capital exemption”) and directs the Commission to define “venture capital fund” within one year of enactment.
18

New section 203(m) of the Advisers Act directs the Commission to provide an exemption from registration to any investment adviser that solely advises private funds if the adviser has assets under management in the United States of less than $150 million (the “private fund adviser exemption”).
19

In this Release, we will refer to advisers that rely on the venture capital and private fund adviser exemptions as “exempt reporting advisers” because sections 203(l) and 203(m) provide that the Commission shall require such advisers to maintain such records and to submit such reports “as the Commission determines necessary or appropriate in the public interest or for the protection of investors.”
20

15
Section 403 of the Dodd-Frank Act amended section 203(b)(3) of the Advisers Act by repealing the prior private adviser exemption and inserting a “foreign private adviser exemption.”
See

infra
Section II.C. Unlike our 2004 rule, which sought to apply only to advisers of “hedge funds,” the Dodd-Frank Act requires that, unless another exemption applies, all advisers previously eligible for the private adviser exemption register with us regardless of the type of private funds or other clients the adviser has.

16
Title IV also created exemptions and exclusions in addition to the three discussed at length in this Release.
See,
e.g.,
sections 403 and 409 of the Dodd-Frank Act (exempting advisers to licensed small business investment companies from registration under the Advisers Act and excluding family offices from the definition of “investment adviser” under the Advisers Act). We are adopting a rule defining “family office” in a separate release (
Family Offices,
Investment Advisers Act Release No. 3220 (June 22, 2011)).

17
Section 419 of the Dodd-Frank Act (specifying the effective date for Title IV).

18

See
section 407 of the Dodd-Frank Act (exempting advisers solely to “venture capital funds,” as defined by the Commission).

19

See
section 408 of the Dodd-Frank Act (directing the Commission to exempt private fund advisers with less than $150 million in aggregate assets under management in the United States).

20

See
sections 407 and 408 of the Dodd-Frank Act.

Section 203(b)(3) of the Advisers Act, as amended by the Dodd-Frank Act, provides an exemption for certain foreign private advisers (the “foreign private adviser exemption”).
21

The term “foreign private adviser” is defined in new section 202(a)(30) of the Advisers Act as an investment adviser that has no place of business in the United States, has fewer than 15 clients in the United States and investors in the United States in private funds advised by the adviser,
22

and less than $25 million in aggregate assets under management from such clients and investors.
23

21
Advisers specifically exempt under section 203(b) are not subject to reporting or recordkeeping provisions under the Advisers Act, and are not subject to examination by our staff.
See

supra
note 5.

22
Subparagraph (B) of section 202(a)(30) refers to the number of “clients and investors in the United States in private funds,” while subparagraph (C) refers to the assets of “clients
in the United States
and investors in the United States in private funds” (emphasis added). We interpret these provisions consistently so that only clients
in the United States
and investors in the United States should be included for purposes of determining eligibility for the exemption under subparagraph (B).

23
The exemption is not available to an adviser that “acts as—(I) an investment adviser to any investment company registered under the [Investment Company Act]; or (II) a company that has elected to be a business development company pursuant to section 54 of [that Act], and has not withdrawn its election.” Section 202(a)(30)(D)(ii). We interpret subparagraph (II) to mean that the exemption is not available to an adviser
that advises
a business development company. This exemption also is not available to an adviser that holds itself out generally to the public in the United States as an investment adviser. Section 202(a)(30)(D)(i).

These new exemptions are not mandatory.
24

Thus, an adviser that qualifies for any of the exemptions could choose to register (or remain registered) with the Commission, subject to section 203A of the Advisers Act, which generally prohibits most advisers from registering with the Commission if they do not have at least $100 million in assets under management.
25

24
An adviser choosing to avail itself of an exemption under section 203(l), 203(m) or 203(b)(3), however, may be required to register as an adviser with one or more state securities authorities.
See
section 203A(b)(1) of the Advisers Act (exempting from state regulatory requirements any adviser registered with the Commission or that is not registered because such person is excepted from the definition of an investment adviser under section 202(a)(11)).
See also

infra
note 488 (discussing the application of section 222 of the Advisers Act).

25
Section 203A(a)(1) of the Advisers Act generally prohibits an investment adviser regulated by the state in which it maintains its principal office and place of business from registering with the Commission unless it has at least $25 million of assets under management. Section 203A(b) preempts certain state laws regulating advisers that are registered with the Commission. Section 410 of the Dodd-Frank Act amended section 203A(a) to also prohibit generally an investment adviser from registering with the Commission if the adviser has assets under management between $25 million and $100 million and the adviser is required to be registered with, and if registered, would be subject to examination by, the state security authority where it maintains its principal office and place of business.
See
section 203A(a)(2) of the Advisers Act. In each of subparagraphs (1) and (2) of section 203A(a), additional conditions also may apply.
See
Implementing Adopting Release,
infra
note 32, at section II.A.

On November 19, 2010, the Commission proposed three rules that would implement these exemptions.
26

First, we proposed rule 203(l)-1 to define the term “venture capital fund” for purposes of the venture capital exemption. Second, we proposed rule 203(m)-1 to implement the private fund adviser exemption. Third, in order to clarify the application of the foreign private adviser exemption, we proposed new rule 202(a)(30)-1 to define several terms included in the statutory definition of a foreign private adviser as defined in section 202(a)(30) of the Advisers Act.
27

On the same day, we

also proposed rules to implement other amendments made to the Advisers Act by the Dodd-Frank Act, which included reporting requirements for exempt reporting advisers.
28

26

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. 3111 (Nov. 19, 2010) [75 FR 77190 (Dec. 10, 2010)] (“Proposing Release”).

27
Proposed rule 202(a)(30)-1 included definitions for the following terms: (i) “Client;” (ii) “investor;” (iii) “in the United States;” (iv) “place of business;” and (v) “assets under management.”
See
discussion in section II.C of the Proposing Release,
supra
note 26. We proposed rule 202(a)(30)-1, in part, pursuant to section 211(a) of

the Advisers Act, which Congress amended to explicitly provide us with the authority to define technical, trade, and other terms used in the Advisers Act.
See
section 406 of the Dodd-Frank Act.

28

Rules Implementing Amendments to the Investment Advisers Act of 1940,
Investment Advisers Act Release No. 3110 (Nov. 19, 2010) [75 FR 77052 (Dec. 10, 2010)] (“Implementing Proposing Release”).

We received over 115 comment letters in response to our proposals to implement the new exemptions.
29

Most of these letters were from venture capital advisers, other types of private fund advisers, and industry associations or law firms on behalf of private fund and foreign investment advisers.
30

We also received several letters from investors and investor groups.
31

Although commenters generally supported the various proposed rules, many suggested modifications designed to expand the breadth of the exemptions or to clarify the scope of one or more elements of the proposed rules. Commenters also sought interpretative guidance on certain aspects of the scope of each of the rule proposals and related issues.

29
The comment letters on the Proposing Release (File No. S7-37-10) are available at:
http://www.sec.gov/comments/s7-37-10/s73710.shtml.
We also considered comments submitted in response to the Implementing Proposing Release that were germane to the rules adopted in this Release.

30

See, e.g.,
Comment Letter of Biotechnical Industry Organization (Jan. 24, 2011) (“BIO Letter”); Comment Letter of Coalition of Private Investment Companies (Jan. 28, 2011) (“CPIC Letter”); Comment Letter of European Private Equity and Venture Capital Association (Jan. 24, 2011 (“EVCA Letter”); Comment Letter of O'Melveny & Myers LLP (Jan. 25, 2011) (“O'Melveny Letter”); Comment Letter of Norwest Venture Partners (Jan. 24, 2011) (“Norwest Letter”).

31

See,

e.g.,
Comment Letter of the American Federation of Labor and Congress of Industrial Organizations (Jan. 24, 2011) (“AFL-CIO Letter”); Comment Letter of Americans for Financial Reform (Jan. 24, 2011) (“AFR Letter”); Comment Letter of The California Public Employees Retirement System (Feb. 10, 2011) (“CalPERS Letter”).
See also, e.g.,
Comment Letter of Adams Street Partners (Jan. 24, 2011); Comment Letter of Private Equity Investors, Inc. (Jan. 21, 2011) (“PEI Funds Letter”) (letters from advisers of funds that invest in other venture capital and private equity funds).

II. Discussion

Today, the Commission is adopting rules to implement the three new exemptions from registration under the Advisers Act. In response to comments, we have made several modifications to the proposals. In a separate companion release (the “Implementing Adopting Release”) we are adopting rules to implement other amendments made to the Advisers Act by the Dodd-Frank Act, some of which also concern certain advisers that qualify for the exemptions discussed in this Release.
32

32

Rules Implementing Amendments to the Investment Advisers Act of 1940,
Investment Advisers Act Release No. 3221 (June 22, 2011).

A. Definition of Venture Capital Fund

We are adopting new rule 203(l)-1 to define “venture capital fund” for purposes of the new exemption for investment advisers that advise solely venture capital funds.
33

In summary, the rule defines a venture capital fund as a private fund that: (i) Holds no more than 20 percent of the fund's capital commitments in non-qualifying investments (other than short-term holdings) (“qualifying investments” generally consist of equity securities of “qualifying portfolio companies” that are directly acquired by the fund, which we discuss below); (ii) does not borrow or otherwise incur leverage, other than limited short-term borrowing (excluding certain guarantees of qualifying portfolio company obligations by the fund); (iii) does not offer its investors redemption or other similar liquidity rights except in extraordinary circumstances; (iv) represents itself as pursuing a venture capital strategy to its investors and prospective investors; and (v) is not registered under the Investment Company Act and has not elected to be treated as a business development company (“BDC”).
34

Consistent with the proposal, rule 203(l)-1 also “grandfathers” any pre-existing fund as a venture capital fund if it satisfies certain criteria under the grandfathering provision.
35

An adviser is eligible to rely on the venture capital exemption only if it solely advises venture capital funds that meet all of the elements of the definition or funds that have been grandfathered.

33
Rule 203(l)-1.

34
Rule 203(l)-1(a).

35
Rule 203(l)-1(b).

The proposed rule defined the term venture capital fund in accordance with what we believed Congress understood venture capital funds to be, as reflected in the legislative materials, including the testimony Congress received.
36

As we discussed in the Proposing Release, the proposed definition of venture capital fund was designed to distinguish venture capital funds from other types of private funds, such as hedge funds and private equity funds, and to address concerns expressed by Congress regarding the potential for systemic risk.
37

36

See
Proposing Release,
supra
note 26, at n.38 and accompanying and following text.

37

See, e.g.,
Proposing Release,
supra
note 26, discussion at section II.A. and text accompanying nn.43, 60, 61, 82, 99, 136.

We received over 70 comment letters on the proposed venture capital fund definition, most of which were from venture capital advisers or related industry groups.
38

A number of commenters supported the Commission's efforts to define a venture capital fund,
39

citing the “thoughtful” approach taken and the quality of the proposed rule.
40

Commenters representing investors and investor groups and others generally supported the rule as proposed,
41

one of which stated that the proposed definition “succeeds in clearly defining those private funds that will be exempt.”
42

Some of these commenters expressed support for a definition that is no broader than necessary in order to ensure that only advisers to “venture capital funds, and not other types of private funds, are able to avoid the new mandatory registration requirements.”
43

38
The National Venture Capital Association submitted a comment letter, dated January 13, 2011 (“NVCA Letter”) on behalf of its members, and 27 other commenters expressed their support for the comments raised in the NVCA Letter.

39

See
BIO Letter; Comment Letter of Charles River Ventures (Jan. 21, 2011) (“Charles River Letter”); NVCA Letter.

40

See, e.g.,
Comment Letter of Abbott Capital Management, LLC (Jan. 24, 2011) (“Abbott Capital Letter”); Comment Letter of DLA Piper LLP (Jan. 24, 2011) (“DLA Piper VC Letter”); Comment Letter of InterWest General Partners (Jan. 21, 2011) (“InterWest Letter”); NVCA Letter; Comment Letter of Oak Investment Partners (Jan. 24, 2011) (“Oak Investment Letter”); Comment Letter of Pine Brook Road Advisors, LP (Jan. 24, 2011) (“Pine Brook Letter”).

41

See
AFR Letter; AFL-CIO Letter; EVCA Letter; Comment Letter of U.S. Senator Carl Levin (Jan. 25, 2011) (“Sen. Levin Letter”).

42
AFL-CIO Letter.

43
Sen. Levin Letter. Although they did not object to the approach taken by the proposed rule, several commenters cautioned us against defining venture capital fund more broadly than necessary to preclude advisers to other types of private funds from qualifying under the venture capital exemption.
See
AFR Letter; CalPERS Letter; Sen. Levin Letter (“a variety of advisers or funds are likely to try to seek refuge from the registration requirement by urging an overbroad interpretation of the term `venture capital fund' * * * It is important for the Commission to define the term narrowly to ensure that only venture capital funds, and not other types of private funds, are able to avoid the new mandatory registration requirement.”).

Generally, however, our proposal prompted vigorous debate among commenters on the scope of the definition. For example, a number of commenters wanted us to take a different approach from the proposal and supported two alternatives. Two commenters urged us to rely on the California definition of “venture capital

operating company.”
44

These commenters did not, however, address our concern, discussed in the Proposing Release, that the California definition includes many types of private equity and other private funds, and thus incorporation of this definition would not appear consistent with our understanding of the intended scope of section 203(l).
45

Our concern was acknowledged in a letter we received from the current Commissioner for the California Department of Corporations, stating that “we understand the [Commission] cannot adopt verbatim the California definition of [venture capital fund]. Congressional directives require the [Commission] to exclude private equity funds, or any fund that pivots its investment strategy on the use of debt or leverage, from the definition of [venture capital fund].”
46

For these reasons and the other reasons cited in the Proposing Release, we are not modifying the proposal to rely on the California definition.
47

44
Comment Letter of Lowenstein Sandler PC (Jan. 4, 2011) (“Lowenstein Letter”); Comment Letter of Keith Bishop (Jan. 17, 2011).

45

See
Proposing Release,
supra
note 26, at n.72 and accompanying and preceding text.

46
Comment Letter of Preston DuFauchard, Commissioner for the California Department of Corporations (Jan. 21, 2011) (“DuFauchard Letter”) (further stating that “while regulators might have an interesting discussion on whether private equity funds contributed to the recent financial crisis, in light of the Congressional directives such a dialogue would be academic.”).

47

See
Proposing Release,
supra
note 26, at n.72 and accompanying and preceding text.

Several other commenters favored defining a venture capital fund by reference to investments in “small” businesses or companies, although they disagreed on the factors that would deem a business or company to be “small.”
48

As discussed in the Proposing Release, we considered defining a qualifying fund as a fund that invests in small companies, but noted the lack of consensus for defining such a term.
49

We also expressed the concern in the Proposing Release that defining a “small” company in a manner that imposes a single standardized metric such as net income, the number of employees, or another single factor test could ignore the complexities of doing business in different industries or regions. This could have the potential result that even a low threshold for a size metric could inadvertently restrict venture capital funds from funding otherwise promising young small companies.
50

For these reasons, we are not persuaded that the tests for a “small” company suggested by commenters address these concerns.

48

See
Comment Letter of National Association of Small Business Investment Companies and Small Business Investor Alliance (Jan. 24, 2011) (“NASBIC/SBIA Letter”) (supported a definition of “small” company by reference to the standards set forth in the Small Business Investment Act regulations).
But

cf.
Lowenstein Letter; Comment Letter of Quaker BioVentures (Jan. 24, 2011) (“Quaker BioVentures Letter”); Comment Letter of Venrock (Jan. 23, 2011) (“Venrock Letter”) (each of which supported a definition of small company based on the size of its public float).
See also
Comment Letter of Georg Merkl (Jan. 25, 2011) (“Merkl Letter”) (referring to “young, negative EBITDA [earnings before interest, taxes, depreciation and amortization] companies”).

49

See
Proposing Release,
supra
note 26, at section II.A.1.a. and n.69 and accompanying and following text.

50

See
Proposing Release,
supra
note 26, at n.69 and accompanying and preceding text.

Unlike the commenters who suggested these alternative approaches, most commenters representing venture capital advisers and related groups accepted the approach of the proposed rule, and many of them acknowledged that the proposed definition would generally encompass most venture capital investing activity that typically occurs.
51

Several, however, also expressed the concern that a venture capital fund may, on occasion, deviate from its typical investing pattern with the result that the fund could not satisfy all of the definitional criteria under the proposed rule with respect to each investment all of the time.
52

Others explained that an investment fund that seeks to satisfy the definition of a venture capital fund (a “qualifying fund”) would desire flexibility to invest small amounts of fund capital in investments that would not meet the criteria under the proposed rule, such as shares of other venture capital funds,
53

non-convertible debt,
54

or publicly traded securities.
55

Both groups of commenters urged us to accommodate them by broadening the definition and modifying the proposed criteria.

51

See, e.g.,
Comment Letter of the Committee on Federal Regulation of Securities of the American Bar Association (Jan. 31, 2011) (“ABA Letter”); ATV Letter; BIO Letter; NVCA Letter; Comment Letter of Proskauer LLP (Jan. 23, 2011); Comment Letter of Union Square Ventures, LLC (Jan. 24, 2011) (“Union Square Letter”).

52

See, e.g.,
Comment Letter of Advanced Technology Ventures (Jan. 24, 2011) (“ATV Letter”); BIO Letter; NVCA Letter; Comment Letter of Sevin Rosen Funds (Jan. 24, 2011) (“Sevin Rosen Letter”). One commenter argued that the rule “should not bar the occasional, but also quite ordinary, financial activities” of a venture capital fund. Charles River Letter.

53

See, e.g.,
Comment Letter of Dechert LLP (Jan. 24, 2011) (“Dechert General Letter”); Comment Letter of First Round Capital (Jan. 24, 2011) (“First Round Letter”); Sevin Rosen Letter.

54

See, e.g.,
Comment Letter of BioVentures Investors (Jan. 24, 2011) (“BioVentures Letter”); Charles River Letter; Comment Letter of Davis Polk & Wardwell LLP (Jan. 24, 2011) (“Davis Polk Letter”); Merkl Letter.

55

See, e.g.,
Comment Letter of Cardinal Partners (Jan. 24, 2011) (“Cardinal Letter”); Davis Polk Letter; Comment Letter of Gunderson Dettmer Stough Villeneuve Franklin & Hachigian (Jan. 24, 2011) (“Gunderson Dettmer Letter”); Merkl Letter.

Commenters wanted advisers seeking to be eligible for the venture capital exemption to have greater flexibility to operate and invest in portfolio companies and to accommodate existing (and potentially evolving) business practices that may vary from what commenters characterized as typical venture capital fund practice.
56

Some argued that a limited basket for such atypical investing activity could facilitate job creation and capital formation.
57

They were also concerned that the multiple detailed criteria of the proposed rule could result in “inadvertent” violations of the criteria under the rule.
58

Some expressed concern that a Commission rule defining a venture capital fund by reference to investing activity would have the result of reducing an adviser's investment discretion.
59

56

See, e.g.,
NVCA Letter; Comment Letter of Bessemer Venture Partners (Jan. 24, 2011) (“Bessemer Letter”); Oak Investment Letter.
See
also
supra

note 51.

57

See, e.g.,
NVCA Letter (stating that a low level of 15% would “allow innovation and job creation to flourish within the venture capital industry”); Sevin Rosen Letter (a 20% limit would be “flexible enough not to severely impair the operations of bona fide [venture capital funds], a critically important resource for American innovation and job creation”).

58

See, e.g.,
NVCA Letter (“Because of the consequence (
i.e.,
Federal registration) of having even one inadvertent, non-qualifying investment, allowance for unintended or insignificant deviations, or differences in interpretations, is appropriate.”); Comment Letter of SV Life Sciences (Jan. 21, 2011) (“SV Life Sciences Letter”) (the “lack of flexibility and ambiguity in certain definitions * * * could cause our firm or other venture firms to inadvertently hold non-qualifying investments”).
See also
ATV Letter.

59
DuFauchard Letter (“Only the VC Fund advisers/managers are in a position to determine what best form `down-round' financing should take. Whether that should be new capital, project finance, a bridge loan, or some other form of equity or debt, is neither a question for the regulators nor should it be a question of strict regulatory control.”); ESP Letter (“There is no way a single regulation can determine what the appropriate level of leverage should be for every portfolio company.”); Merkl Letter (“The Commission should not regulate from whom the [portfolio company] securities can be acquired or how the [company's] capital can be used.”).

We are sensitive to commenters' concerns that the definition not operate to foreclose investment funds from investment opportunities that would benefit investors but would not change the character of a venture capital fund.
60

On the other hand, we are troubled that the cumulative effect of revising the rule to reflect all of the modifications supported by commenters could permit reliance on the exemption by advisers to other types of private funds and thus

expand the exemption beyond what we believe was the intent of Congress.
61

A number of commenters argued that defining a venture capital fund by reference to multiple detailed criteria could result in “inadvertent” violations of the definitional criteria by a qualifying fund.
62

Another commenter acknowledged that providing
de minimis
carve-outs to the multiple criteria under the proposed rule could be “cumbersome,”
63

which could lead to the result, asserted by some commenters, that an overly prescriptive rule could invite further unintentional violations of the registration provisions of the Advisers Act.
64

60

See, e.g.,
Oak Investment Letter; Sevin Rosen Letter.

61
For example, one commenter suggested that the definition of venture capital fund include a fund that incurs leverage of up to 20% of fund capital commitments without limit on duration and invests up to 20% of fund capital commitments in publicly traded securities and an additional 20% of fund capital commitments in non-conforming investments. Charles River Letter. Under these guidelines, it would be possible to structure a fund that borrows up to 20% of the fund's “capital commitments” to acquire highly leveraged derivatives and publicly traded debt securities. If the fund only calls 20% of its capital, fund indebtedness would equal 100% of fund assets, all of which would be in derivative instruments or publicly traded debt securities.

62

See supra
note 58.

63
First Round Letter.

64

See, e.g.,

generally
NVCA Letter.
See

also
Merkl Letter.

To balance these competing considerations, we are adopting an approach suggested by several commenters that defines a venture capital fund to include a fund that invests a portion of its capital in investments that would not otherwise satisfy all of the elements of the rule (“non-qualifying basket”).
65

Defining a venture capital fund to include funds engaged in some amount of non-qualifying investment activity provides advisers to venture capital funds with greater investment flexibility, while precluding an adviser relying on the exemption from altering the character of the fund's investments to such extent that the fund could no longer be viewed as a venture capital fund within the intended scope of the exemption. To the extent an adviser uses the basket to invest in some non-qualifying investments, it will have less room to invest in others, but the choice is left to the adviser. While the definition limits the amount of non-qualifying investments, it allows the adviser to choose how to allocate those investments. Thus, one venture capital fund may take advantage of some opportunities to invest in debt whereas others may seek limited opportunities in publicly offered securities. The definition of “business development company” under the Advisers Act contains a similar basket for non-qualifying investments.
66

65

See, e.g.,
Abbott Capital Letter; ATV Letter; Bessemer Letter; BioVentures Letter; Cardinal Letter; Charles River Letter; Comment Letter of CompliGlobe Ltd. (Jan. 24, 2011) (“CompliGlobe Letter”); Davis Polk Letter; First Round Letter; NVCA Letter; Comment Letter of PTV Sciences (Jan. 24, 2011) (“PTV Sciences Letter”); Quaker BioVentures; Comment Letter of Santé Ventures (Jan. 24, 2011) (“Santé Ventures Letter”); Sevin Rosen Letter; SV Life Sciences; Comment Letter of U.S. Venture Partners (Jan. 24, 2011) (“USVP Letter”); Venrock Letter.

66
Advisers Act section 202(a)(22) (defining a “business development company” as any company that meets the definition set forth in section 2(a)(48) of, and complies with section 55 of, the Investment Company Act, except that a BDC under the Advisers Act is defined to mean a company that invests 60% of its total assets in the assets specified in section 55 of the Investment Company Act).

Commenters suggested non-qualifying baskets ranging from 15 to 30 percent of a fund's capital commitments, although many of these same commenters wanted us to expand the other criteria of the proposed rule.
67

Several commenters in favor of a non-qualifying basket asserted that setting the level for non-qualifying investments at a sufficiently low threshold would preclude advisers to other types of private funds from relying on the venture capital exemption while providing venture capital advisers the flexibility to take advantage of investment opportunities.
68

These commenters properly framed the question before us. We did not, however, receive specific empirical analysis regarding the venture capital industry as a whole that would help us determine the appropriate size of the basket.
69

Many of those supporting a 15 percent non-qualifying basket also supported expanding some of the other elements of the definition, and thus it is unclear whether a 15 percent non-qualifying basket alone would satisfy their needs.
70

On the other hand, those supporting a much larger basket did not, in our view, adequately address our concern that an overly expansive definition would provide room for advisers to private equity funds to remain unregistered, a consequence several commenters urged us to avoid.
71

67

See, e.g.,
NVCA Letter (more than 25 comment letters expressed general support for the comments raised in the NVCA Letter). Two commenters expressed support for a 30% basket for non-qualifying investments.
See
Comment Letter of Shearman & Sterling LLP (Jan. 24, 2011) (“Shearman Letter”) (citing, in support of this position, the BDC definition under the Investment Company Act, which specifies a threshold of 30% for non-qualifying activity); Quaker BioVentures Letter (citing, in support of this position, the BDC definition under the Investment Company Act and the BDC definition under the Advisers Act which increased the non-qualifying activity threshold to 40%).

68
Norwest Letter; Sevin Rosen Letter (noting that a 20% limit is “low enough to ensure that only true [venture capital funds] are able to qualify for the [venture capital] exemption.”).
See also
NVCA Letter.

69
We did, however, receive much anecdotal evidence of particular advisers' experiences with non-qualifying investments.
See, e.g.,
Cardinal Letter (“In a very limited number of cases, it has been necessary for us to purchase securities from current shareholders of the portfolio company in order for the financing to be completed. However, in NO case have purchases from existing shareholders ever exceeded 15% of the total investment by Cardinal in a proposed financing.”); Charles River Letter (“The vast majority of our investments are in the form of Convertible Preferred Stock. * * * However, very rarely—but more often than never—- we invest in the form of a straight, non-convertible Demand Note.”); Pine Brook Letter (“Our fund documents provide for investments outside of our core investing practice of up to 25% of our committed capital.”).
But

cf.
Mesirow Financial Private Equity Advisors, Inc. (Jan. 24, 2011) (“Mesirow Letter”) (a Commission-registered adviser that advises funds that invest in other venture capital and private equity funds stated that “[s]ince the main purpose of [venture capital funds] is to invest in and help build operating companies, we believe their participation in non-qualifying activity will be rare.”).

70

See

supra
note 67.

71

See

supra
note 43.

On balance, and after giving due consideration to the approaches suggested by commenters, we are adopting a limit of 20 percent of a qualifying fund's capital commitments for non-qualifying investments. We believe that a 20 percent limit will provide the flexibility sought by many venture capital fund commenters while appropriately limiting the scope of the exemption. We note that several commenters recommended a non-qualifying basket limit of 20 percent.
72

72

See, e.g.,
ATV Letter; Charles River Letter; Sevin Rosen Letter. At least one commenter stated that the minimum threshold limit for the non-qualifying basket should be 20%. Charles River Letter (“we believe anything less than 20% would be inadequate”).

We considered adopting a 40 percent basket for non-qualifying investments by analogy to the Advisers Act definition of BDC.
73

That basket was established by Congress rather than the Commission, and it strikes us as too large in light of our task of implementing a statutory provision that does not specify a basket.
74

We find a better analogy in a rule we adopted in 2001 under the Investment Company Act. Under rule 35d-1 of that Act, commonly referred to as the “names rule,” an investment company with a name suggesting that it invests in certain investments is limited to investing no more than 20 percent of its assets in other types of investments (
i.e.,

non-qualifying investments).
75

In adopting that rule, we explained that “if an investment company elects to use a name that suggests its investment policy, it is important that the level of required investments be high enough that the name will accurately reflect the company's investment policy.”
76

We noted that having a registered investment company hold a significant amount of investments consistent with its name is an important tool for investor protection,
77

but setting the limit at 20 percent gives the investment company management flexibility.
78

While our policy goal today in defining a “venture capital fund” is somewhat different from our goal in prescribing limitations on investment company names, the tensions we sought to reconcile are similar.
79

73

See

supra
note 66.

74
A larger non-qualifying basket of 40% could have the result of changing the fundamental underlying nature of the investments held by a qualifying fund, such as for example increasing the extent to which non-qualifying investments may contribute to the returns of the fund's portfolio.

75
Rule 35d-1(a)(2) under the Investment Company Act (“a materially deceptive and misleading name of a [registered investment company] includes * * * [a] name suggesting that the [registered investment company] focuses its investments in a particular type of investment or investments, or in a particular industry or group of industries, unless: (i) The [registered investment company] has adopted a policy to invest, under normal circumstances, at least 80% of the value of its [total assets] in the particular type of investments, or in investments in the particular industry or industries, suggested by the [registered investment company's] name * * *”). 17 CFR 270.35d-1(a)(2).

76

Investment Company Names,
Investment Company Act Release No. 24828 (Jan. 17, 2001) [66 FR 8509, 8511 (Feb. 1, 2001), correction 66 FR 14828 (Mar. 14, 2001)] (“Names Rule Adopting Release”).

77
Names Rule Adopting Release,
supra
note 76, at text accompanying n.3 and text following n.7.

78

See
Names Rule Adopting Release,
supra
note 76, at text accompanying n.14.
See

also
NVCA Letter; Sevin Rosen Letter (citing rule 35d-1 in support of recommending that the rule adopt a non-qualifying basket); Quaker BioVentures Letter (citing the approach taken by the staff generally limiting an investment company excluded by reason of section 3(c)(5)(C) of the Investment Company Act to investing no more than 20% of its assets in non-qualifying investments).

79
A number of commenters recommended that the rule specify a range for the non-qualifying basket, arguing that this approach would provide advisers to venture capital funds with better flexibility to manage their investments over time.
See, e.g.,
DLA Piper VC Letter; DuFauchard Letter; Norwest Letter; Oak Investment Letter. As we discuss in greater detail below, the non-qualifying basket is determined as of the time immediately following each investment and hence a range is not necessary.

1. Qualifying Investments

Under the rule, to meet the definition of venture capital fund, the fund must hold, immediately after the acquisition of any asset (other than qualifying investments or short-term holdings), no more than 20 percent of the fund's capital commitments in non-qualifying investments (other than short-term holdings).
80

Thus, as discussed above, a qualifying fund could invest without restriction up to 20 percent of the fund's capital commitments in non-qualifying investments and would still fall within the venture capital fund definition.

80
Rule 203(l)-1(a)(2). The rule specifies that “immediately after the acquisition of any asset (other than qualifying investments or short-term holdings)” no more than 20% of the fund's aggregate capital contributions and uncalled committed capital may be held in assets (other than short-term holdings) that are not qualifying investments.”
See

infra
Section II.A.1.c. for a discussion on the operation of the 20% limit.

For purposes of the rule, a “qualifying investment,” which we discuss in greater detail below, generally consists of any equity security issued by a qualifying portfolio company that is directly acquired by a qualifying fund and certain equity securities exchanged for the directly acquired securities.
81

81

See
Sections II.A.1.b.

a. Equity Securities of Portfolio Companies

Rule 203(l)-1 defines a venture capital fund as a private fund that, excluding investments in short-term holdings and non-qualifying investments, generally holds equity securities of qualifying portfolio companies.
82

82
Rule 203(l)-1(a)(2) (specifying the investments of a venture capital fund); (c)(3) (defining “qualifying investment”); and (c)(6) (defining “short-term holdings”).

We proposed to define “equity security” by reference to the Exchange Act.
83

Commenters did not generally object to our proposal to do so, although many urged that we expand the definition of venture capital fund to include investments in other types of securities.
84

Commenters asserted that venture capital funds may invest in securities other than equity securities (including debt securities) for various business reasons, including to provide “bridge” financing to portfolio companies between equity financing rounds,
85

for working capital needs
86

or for tax or structuring reasons.
87

Many of these commenters recommended that the rule also define a venture capital fund to include funds that invest in non-convertible bridge loans of a portfolio company,
88

interests in other pooled investment funds (including other venture capital funds)
89

and publicly offered securities.
90

Commenters argued that these types of investments facilitate access to capital for a company's expansion,
91

offer qualifying funds flexibility to structure investments in a manner that is most appropriate for the fund (and its investors), including for example to obtain favorable tax treatment, manage risks (such as bankruptcy protection), maintain the value of the fund's equity investment or satisfy the specific financing needs of a portfolio company,
92

and enable a portfolio company to seek such financing from venture capital funds if the company is unable to obtain financing from traditional lending sources.
93

83
Proposed rule 203(l)-1(c)(2).

84
Several commenters opposed any restriction on the definition of equity security.
See, e.g.,
Bessemer Letter; ESP Letter; NVCA Letter.

85
ATV Letter; NVCA Letter.

86
Comment Letter of Cook Children's Health Care Foundation Investment Committee (Jan. 20, 2011) (“Cook Children's Letter”); Comment Letter of Leland Fikes Foundation, Inc. (Jan. 21, 2011) (“Leland Fikes Letter”).

87
Bessemer Letter; Merkl Letter.

88

See, e.g.,
Comment Letter of CounselWorks LLC (Jan. 24, 2011); ESP Letter; Comment Letter of McGuireWoods LLP (Jan. 24, 2011) (“McGuireWoods Letter”); NVCA Letter; Oak Investment Letter.
See also
BioVentures Letter (supported venture capital fund investments in non-convertible debt without a time limit); Cook Children's Letter; Leland Fikes Letter (each of which expressed general support). One commenter indicated that the proposed condition limiting investments in portfolio companies to equity securities was too narrow.
See
Pine Brook Letter.

89

See,

e.g.,
Cook Children's Letter; Leland Fikes Letter; PEI Funds Letter; Comment Letter of SVB Financial Group (Jan. 24, 2011) (“SVB Letter”).

90

See,

e.g.,
ATV Letter; BIO Letter (noted that investments by venture capital funds in “PIPEs” (
i.e.,
“private investments in public equity”) are “common”).

91

See, e.g.,
Lowenstein Letter; Comment Letter of John G. McDonald (Jan. 21, 2011) (“McDonald Letter”); Quaker BioVentures Letter; Comment Letter of Trident Capital (Jan. 24, 2011) (“Trident Letter”).

92

See, e.g.,
Merkl Letter; Oak Investments Letter; Sevin Rosen Letter; Comment Letter of Vedanta Capital, LP (Jan. 24, 2011) (“Vedanta Letter”).

93
NVCA Letter; Trident Letter.

We recognize that a venture capital fund may, on occasion, make investments other than in equity securities.
94

Under the rule, as discussed above, a venture capital fund may make these investments (as well as other types of investments that commenters may not have suggested) to the extent there is room in the fund's non-qualifying basket. Hence, we are adopting the definition of equity security as proposed.

94

See, e.g.,
ESP Letter; Leland Fikes Letter; McGuireWoods Letter; NVCA Letter; Oak Investment Letter.
See

also

supra
Section II.A.

The final rule incorporates the definition of equity security in section 3(a)(11) of the Exchange Act and rule 3a11-1 thereunder.
95

Accordingly,

equity security includes common stock as well as preferred stock, warrants and other securities convertible into common stock in addition to limited partnership interests.
96

Our definition of equity security is broad. The definition includes various securities in which venture capital funds typically invest and provides venture capital funds with flexibility to determine which equity securities in the portfolio company capital structure are appropriate for the fund. Our use of the definition of equity security under the Exchange Act acknowledges that venture capital funds typically invest in common stock and other equity instruments that may be convertible into equity common stock but does not otherwise specify the types of equity instruments that a venture capital fund could hold in deference to the business judgment of venture capital funds.

95
Rule 203(l)-1(c)(2) (equity security “has the same meaning as in section 3(a)(11) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(11)) and § 240.3a11-1 of this chapter.”).
See
15 U.S.C. 78c(a)(11) (defining “equity security” as “any stock or similar security; or any security future on any such security; or any security convertible, with or without consideration, into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any other security which the Commission

shall deem to be of similar nature and consider necessary or appropriate, by such rules and regulations as it may prescribe in the public interest or for the protection of investors, to treat as an equity security.”); rule 3a11-1 under the Exchange Act (17 CFR 240.3a11-1) (defining “equity security” to include “any stock or similar security, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, limited partnership interest, interest in a joint venture, or certificate of interest in a business trust; any security future on any such security; or any security convertible, with or without consideration, into such a security, or carrying any warrant or right to subscribe to or purchase such a security; or any such warrant or right; or any put, call, straddle, or other option or privilege of buying such a security from or selling such a security to another without being bound to do so.”).

96

See
rule 3a11-1 under the Exchange Act (17 CFR 240.3a11-1) (defining “equity security” to include any “limited partnership interest”).

b. Capital Used for Operating and Business Purposes

Rule 203(l)-1 defines a venture capital fund as a private fund that holds no more than 20 percent of the fund's capital commitments in non-qualifying investments (other than short-term holdings). Under the final rule, qualifying investments are generally equity securities that were acquired by the fund in one of three ways that suggest that the fund's capital is being used to finance the operations of businesses rather than for trading in secondary markets. As discussed in greater detail below, rule 203(l)-1 defines a “qualifying investment” as: (i) Any equity security issued by a qualifying portfolio company that is directly acquired by the private fund from the company (“directly acquired equity”); (ii) any equity security issued by a qualifying portfolio company in exchange for directly acquired equity issued by the same qualifying portfolio company; and (iii) any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary, or a predecessor, and that is acquired by the fund in exchange for directly acquired equity.
97

97
Rule 203(l)-1(c)(3). A security received as a dividend by virtue of the fund's holding of a qualifying investment would also be a qualifying investment.
See generally infra
note 480.

In the Proposing Release we explained that one of the features of venture capital funds that distinguish them from hedge funds and private equity funds is that they invest capital directly in portfolio companies for the purpose of funding the expansion and development of the companies' business rather than buying out existing security holders.
98

Thus, we proposed that, to meet the definition, at least 80 percent of a fund's investment in each portfolio company must be acquired directly from the company, in effect limiting a venture capital fund's ability to acquire secondary market shares to 20 percent of the fund's investment in each company.
99

98
Proposing Release,
supra
note 26, at text accompanying n.104.

99
Proposed rule 203(l)-1(a)(2).

A few commenters objected to any limitation on secondary market purchases of a qualifying portfolio company's shares,
100

but did not address the critical role this condition played in differentiating venture capital funds from other types of private funds, such as leveraged buyout funds, which acquire controlling equity interests in operating companies through the “buyout” of existing security holders.
101

Nor did they offer an alternative method in lieu of the direct acquisition criterion to distinguish venture capital funds from the buyout funds that are considered private equity funds. We continue to believe that the limit on secondary purchases is an important element for distinguishing advisers to venture capital funds from advisers to the types of private equity funds for which Congress did not provide an exemption.
102

Therefore, we are not modifying the definition of qualifying investment to broadly include equity securities acquired in secondary transactions.

100

See,

e.g.,
ESP Letter; Merkl Letter.

101

See also
Proposing Release,
supra
note 26, at section II.A.1.d.

102

See id.,
at n.112 and accompanying text.

We are, however, making two changes in this provision in response to commenters. First, we have eliminated the 20 percent limit for secondary market transactions that we included in this provision in our proposal in favor of the broader 20 percent limit for assets that are not qualifying investments.
103

Most commenters addressing the limit on secondary market acquisitions supported changing the threshold from 80 percent of the fund's investment in each portfolio company to either 50 percent in each portfolio company,
104

or 80 percent of the fund's total capital commitments.
105

These commenters argued that secondary acquisitions provide liquidity to founders, angel investors and employees/former employees or align the interests of a fund with those of a portfolio company.
106

103

Cf.
proposed rule 203(l)-1(a)(2) and rule 203(l)-1(a)(2).

104

See
DLA Piper VC Letter; Davis Polk Letter; Sevin Rosen Letter (each supported lowering the direct purchase requirement from 80% to 50% of each qualifying portfolio company's equity securities); Dechert General Letter (argued that the 20% allowance for secondary purchases should be increased to 45%, consistent with rules 3a-1 and 3c-5 under the Investment Company Act).
See also
ABA Letter (supported lowering the threshold from 80% to 70%); NVCA Letter; Mesirow Letter; Oak Investments Letter. Several commenters disagreed with the proposed direct acquisition criterion and recommended that venture capital fund investments in portfolio company securities through secondary transactions should not be subject to any limit.
See, e.g.,
ESP Letter; Merkl Letter.

105
ATV Letter; Bessemer Letter; Charles River Letter; Davis Polk Letter; First Round Letter; Gunderson Dettmer Letter; InterWest Letter; Mesirow Letter; Norwest Letter; NVCA Letter; Oak Investment Letter; Sevin Rosen Letter; SVB Letter; Union Square Letter; Vedanta Letter.
See also
Comment Letter of Alta Partners (Jan. 24, 2011) (“Alta Partners Letter”); USVP Letter.

106

See, e.g.,
Bessemer Letter; Norwest Letter; Sevin Rosen Letter.

We believe that the limit on secondary purchases remains an important element for distinguishing advisers to venture capital funds from advisers to the types of private equity funds for which Congress did not provide an exemption.
107

However, as discussed above, a venture capital fund may purchase shares in secondary markets to the extent it has room for such securities in its non-qualifying basket.

107

See
Proposing Release,
supra
note 26, at n.112 and accompanying text.

Second, the final rule defines qualifying investments as including equity securities issued by the qualifying portfolio company that are received in exchange for directly acquired equities issued by the same qualifying portfolio company.
108

This revision was suggested by a number of

commenters to enable a qualifying fund to participate in the reorganization of the capital structure of a portfolio company, which may require the fund, along with other existing security holders, to accept newly issued equity securities in exchange for previously issued equity securities.
109

108
Under rule 203(l)-1(c)(3)(ii), “qualifying investments” include any equity security issued by a qualifying portfolio company in exchange for an equity security issued by the qualifying portfolio company that is directly acquired.
See infra
note 113.

109

See, e.g.,
NVCA Letter.
See

also
Sevin Rosen Letter. Although we understand that the securities received in an exchange are typically newly issued, the rule would also cover exchanges for outstanding securities.
See also infra
note 113.

The rule similarly treats as a qualifying investment any equity security issued by another company in exchange for directly acquired equities of a qualifying portfolio company, provided that the qualifying portfolio company becomes a majority-owned subsidiary of the other company or is a predecessor company.
110

This provision enables a qualifying fund to acquire securities in connection with the acquisition (or merger) of a qualifying portfolio company by another company,
111

without jeopardizing the fund's ability to satisfy the definition of venture capital fund. A venture capital fund's acquisition of publicly offered securities in these circumstances may not present the same degree of interconnectedness with the public markets as secondary acquisitions through the open markets that are typical of other types of leveraged buyout private funds.
112

As a result of the modification to the proposed rule, a venture capital fund could hold equity securities of a company subject to reporting under the Exchange Act, if such equity securities were issued to the fund in exchange for directly acquired equities of a qualifying portfolio company that became a majority-owned subsidiary of the reporting company.
113

110
Under rule 203(l)-1(c)(3)(iii), “qualifying investments” include any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary (as defined in section 2(a)(24) of the Investment Company Act), or a predecessor company, and that is acquired by the private fund in exchange for an equity security described in paragraph (c)(3)(i) or (c)(3)(ii) of the rule.
See infra
note 113.

A “majority-owned subsidiary” is defined by reference to section 2(a)(24) of the Investment Company Act, (15 U.S.C. 80a2(a)(24), which defines a “majority-owned subsidiary” of any person as “a company 50 per centum or more of the outstanding voting securities of which are owned by such person, or by a company which, within the meaning of this paragraph, is a majority-owned subsidiary of such person.”

111

See, e.g.,
Davis Polk Letter; Comment Letter of Institutional Venture Partners (Jan. 24, 2011) (“IVP Letter”); Mesirow Letter; PTV Sciences Letter. A number of commenters argued that without this expanded definition, typical transactions enabling a venture capital fund to restructure its investment in a portfolio company, exit its investment or obtain liquidity for itself and its investors, as well as profits, would be precluded.
See, e.g.,
NVCA Letter; PTV Sciences Letter.

112

See, e.g.,
Davis Polk Letter.
See

also
Mesirow Letter.

113
Under the rule, a qualifying fund could separately purchase additional securities pursuant to a public offering (or recapitalization) from a company after it ceases to be a “qualifying portfolio company” (because for example such company has become a reporting or foreign traded company), subject to the non-qualifying basket.

c. Operation of the 20 Percent Limit

Under the rule, to meet the definition of venture capital fund, a qualifying fund must hold, immediately after the acquisition of any asset (other than qualifying investments or short-term holdings), no more than 20 percent of the fund's capital commitments in non-qualifying investments (other than short-term holdings).
114

Under this approach, a fund need only calculate the 20 percent limit when the fund acquires a non-qualifying investment (other than short-term holdings); after the acquisition, the fund need not dispose of a non-qualifying investment simply because of a change in the value of that investment. A qualifying fund, however, could not purchase additional non-qualifying investments until the value of its then-existing non-qualifying investments fell below 20 percent of the fund's committed capital.

114
Rule 203(l)-1(a)(2). The calculation of the 20% limit operates in a fashion similar to the diversification and “Second Tier Security” tests of rule 2a-7 under the Investment Company Act. 17 CFR 270.2a-7(a)(24).
See

Revisions to Rules Regulating Money Market Funds,
Investment Company Act Release No. 18005 (Feb. 20, 1991) [56 FR 8113, 8118 (Feb. 27, 1991)].

As discussed above, most commenters supporting a basket for non-qualifying investments recommended a limit expressed as a percentage of fund capital commitments.
115

One commenter further suggested that the value of investments included in the non-qualifying basket be calculated at the time each investment is made to include only those non-qualifying investments that are then held by the fund (thus excluding liquidated assets); the commenter argued that this approach would give funds certainty that a qualifying investment would not become “non-qualifying” and simplify the test for compliance.
116

115

See

supra
note 67.

116
Sevin Rosen Letter.
See also
BioVentures Letter (endorsing the NVCA Letter supporting a non-qualifying basket determined as a percentage of fund capital commitments, but also arguing in favor of determining the basket “at any point in time, rather than in the aggregate over the life of the fund”).

We are persuaded that the non-qualifying basket should be based on a qualifying fund's total capital commitments, and the fund's compliance with the 20 percent limit should be calculated at the time any non-qualifying investment is made, based on the non-qualifying investments then held in the fund's portfolio.
117

We understand that using a fund's capital commitments for determining investment thresholds is generally consistent with existing venture capital fund practice,
118

and nearly all of the commenters requesting a basket specified the basket as a percentage of the fund's capital commitments.
119

We expect that calculating the size of the non-qualifying basket as a percentage of a qualifying fund's capital commitments, which will remain relatively constant during the fund's term, will provide advisers with a degree of predictability when managing the fund's portfolio and determining how much of the basket remains available for new investments.

117
Capital commitments that have been called but returned to investors and subject to a future call would be treated as uncalled capital commitments. Capital commitments that are no longer subject to a call by the fund would not be treated as uncalled capital commitments.

118
See
generally
infra

notes 240-243 (discussing the use of a qualifying fund's capital commitments to determine the fund's compliance with the leverage criterion).
See

also
DLA Piper VC Letter.

119

See generally supra
note 67. For purposes of reporting its “regulatory assets under management” on Form ADV, an adviser would include uncalled capital commitments of a private fund advised by the adviser.

We acknowledge that limiting non-qualifying investments to a percentage of fund capital commitments could result in a qualifying fund that invests its initial capital call in non-qualifying investments;
120

but that ability would be constrained by the adviser's need to reconcile that investment with the fund's required representation that it pursues a venture capital strategy.
121

An investment adviser that manages a fund in such a manner that renders the representation to investors and potential investors that the fund pursues a venture capital strategy an untrue statement of material fact would violate the antifraud provisions of the Advisers Act.
122

We understand that a venture capital fund is not typically required to call or fully draw down all of its capital commitments. However, only
bona fide
capital commitments may be included in the calculation under rule 203(l)-

1.
123

For example, commitments made for the purpose of increasing the non-qualifying basket and with an understanding with investors that they will not be called cannot be included.
124

120

See
AFL-CIO Letter; AFR Letter (discussing issues associated with specifying leverage as a percentage of fund capital commitments).

121

See infra
Section II.A.7.

122
The Commission does not need to demonstrate that an adviser violating rule 206(4)-8 acted with
scienter. See

Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles,
Investment Advisers Act Release No. 2628 (Aug. 3, 2007) [72 FR 44756 (Aug. 9, 2007)] (“Pooled Vehicles Release”).

123

See also Investment Adviser Performance Compensation,
Investment Advisers Act Release No. 3198 (May 10, 2011) [76 FR 27959 (May 13, 2011)] at n.17 (in determining whether a person holds the requisite amount of assets under management, an investment adviser may include “assets that a client is contractually obligated to invest in private funds managed by the adviser. Only
bona fide
contractual commitments may be included,
i.e.,
those that the adviser has a reasonable belief that the investor will be able to meet.”).

124
Similarly, fee waivers or reductions for the purpose of inducing investors to increase the size of their capital commitments with an understanding that they will not be called (and hence enable the adviser to increase the size of the non-qualifying basket) would indicate that the commitments are not
bona fide.
In addition, the amount of capital commitments and contributions made by investors and the investments made by the fund are indispensable to the functioning of a venture capital fund, and we understand advisers to venture capital funds typically maintain records reflecting them.
See generally supra
note 5 (describing the Commission's authority to examine the records of advisers relying on the venture capital exemption).

We note that a person claiming an exemption under the Federal securities laws has the burden of proving it is entitled to the exemption.
See, e.g., SEC
v.
Ralston Purina Co.,
346 U.S. 119, 126 (1953);
Gilligan, Will & Co.
v.
SEC,
267 F.2d 461, 466 (2d Cir. 1959);
Swenson v. Engelstad,
626 F.2d 421, 425 (5th Cir. 1980);
SEC
v.
Wall St. Transcript Corp.,
454 F. Supp. 559, 566 (S.D.N.Y. 1978) (stating that the defendant publisher “must register unless it can be shown that it is” entitled to rely on an exclusion from the definition of “investment adviser”).

Moreover, we believe that by applying the 20 percent limit as of the time of acquisition of each non-qualifying investment, a fund is able to determine prospectively how much it can invest in the non-qualifying basket. We believe that this simpler approach to determining the non-qualifying basket would better limit a qualifying fund's non-qualifying investments and ease the burden of determining compliance with the criterion under the rule.

To determine compliance with the 20 percent limit, a venture capital fund would, immediately after the acquisition of any non-qualifying investment, excluding any short-term holdings,
125

calculate the total value of all of the fund's assets held at that time, excluding short-term holdings, that are invested in non-qualifying investments, as a percentage of the fund's total capital commitments.
126

For this purpose, the 20 percent test is determined based on the qualifying fund's non-qualifying investments after taking into account the acquisition of any newly acquired non-qualifying investment.
127

125
Rule 203(l)-1(c)(6) (“Short-term holdings” means cash and cash equivalents as defined in § 270.2a51-1(b)(7)(i), U.S. Treasuries with a remaining maturity of 60 days or less, and shares of an open-end management investment company registered under section 8 of the Investment Company Act of 1940 [15 U.S.C. 80a-8] that is regulated as a money market fund under § 270.2a-7 of this chapter.”).

126
A qualifying investment that is acquired as a result of an exchange of equity securities provided by rule 203(l)-1(c)(3)(ii) and (iii) would not result in a requirement to calculate the 20% limit under rule 203(l)-1(a)(2).

127
Rule 203(l)-1(a)(2).

To determine if a fund satisfies the 20 percent limit for non-qualifying investments, the fund may use either historical cost or fair value, as long as the same method is applied to all investments of a qualifying fund in a consistent manner during the term of the fund.
128

Under the rule, a venture capital fund could use either historical cost or fair value, depending, for example, on the fund's approach to valuing investments since the fund's inception. Under the final rule, a qualifying fund using historical cost need not account for changes in the value of its portfolio due to, for example, market fluctuations in the value of a non-qualifying investment or the sale or other disposition of a qualifying investment (including the associated distribution of sale proceeds to fund investors). Requiring fair value in this particular instance could make investment planning difficult because the amount of dollars allocated to the non-qualifying basket would vary depending on changes in the value of investments already made. In addition, requiring fair value could complicate compliance for those qualifying funds that make investments frequently, because each investment would result in a requirement to value the fund's assets. Because the rule specifies that the valuation method must be consistently applied, this approach is designed to prevent a qualifying fund, or its adviser, from alternating between valuation methodologies in order to circumvent the 20 percent limit.

128

Id.

Our rule's approach to the valuation method, which allows the use of historical cost in determining compliance with the non-qualifying basket limit, is similar in this respect to rules under the Employee Retirement Income Security Act of 1974 (“ERISA”) for funds qualifying as “venture capital operating companies,” which generally specify that the value of a fund's investments is determined on a cost basis.
129

Many commenters cited the ERISA rule in connection with comments on other proposed criteria,
130

and hence we believe advisers' familiarity with the ERISA rule will facilitate compliance with our approach to the 20 percent limit and reduce the burdens associated with compliance.

129
Under U.S. Department of Labor regulations, a venture capital operating company (“VCOC”) is any entity that, as of the date of the first investment (or other relevant time), has at least 50% of its assets (other than short-term investments pending long-term commitment or distribution to investors), valued at cost, invested in venture capital investments. 29 CFR 2510.3-101(d).
See also
Proposing Release,
supra
note 26, at n.70.

130
For example, a number of commenters urged us to adopt the approach under ERISA that would determine whether or not a fund has satisfied the managerial assistance criterion.
See infra
note 225.

2. Short-Term Holdings

A qualifying fund may also invest in cash and cash equivalents, U.S. Treasuries with a remaining maturity of 60 days or less and shares of registered money market funds.
131

A qualifying fund need not include its investments in these short-term holdings when determining whether it satisfies the 20 percent limit for non-qualifying investments.
132

131
Rule 203(l)-1(c)(6).

132
Rule 203(l)-1(a)(2). As proposed, a venture capital fund would have been defined as a fund that invested
solely
in certain investments, including specified cash instruments. Proposed rule 203(l)-1(a)(2)(ii). In the final rule, a venture capital fund is defined as a fund that holds
no more
than 20% of its committed capital in assets that are not qualifying investments, excluding for this purpose short-term holdings (which is defined to include specified cash instruments). Rule 203(l)-1(a)(2). The general focus of both the proposal and the final rule is on the types of investments in which a qualifying fund may invest. As a result of the modifications to the rule to incorporate a non-qualifying basket, we are excluding short-term holdings from the calculation of qualifying and non-qualifying investments.

Most commenters that addressed the cash element of the proposal did not disagree with our approach to the cash element but urged us to expand it to include money market funds,
133

any U.S. Treasury without regard to maturity,
134

debt issued by foreign governments,
135

repurchase agreements,
136

and certain highly rated corporate commercial paper.
137

Many commenters did not provide a rationale, other than business practice, for expanding the cash element to include these other types of investments or discuss whether these changes would also permit other types of funds to meet the definition. One commenter did note, however, that short-term investments are typically held during the period between a capital call and funding by

investors and invested in instruments that may provide higher returns than the cash items identified in the proposed rule.
138

133
Comment Letter of Federated Investors, Inc. (Jan. 18, 2011); IVP Letter; Merkl Letter.

134

See, e.g.,
Dechert General Letter; IVP Letter.
See also
Shearman Letter; SVB Letter (also argued that Treasuries pose no systemic risk issues).

135
Dechert General Letter; Commenter Letter of European Fund and Asset Management Association (Jan. 24, 2011) (“EFAMA Letter”); Merkl Letter.

136
IVP Letter; NVCA Letter.

137
Sevin Rosen Letter.

138
NVCA Letter.

The Commission recognizes that a broader definition of short-term holdings could yield venture capital funds greater returns.
139

The exclusion of short-term holdings from a qualifying fund's assets for purposes of the 20 percent test, however, recognizes that such holdings are not ordinarily held as part of the fund's investment portfolio but as a cash management tool.
140

Advisers to venture capital funds that wish to invest in longer-term or higher yielding debt may make use of the non-qualifying basket for such investments. We are, however, modifying the definition to include as short-term holdings shares of registered money market funds that are regulated under rule 2a-7 under the Investment Company Act,
141

which we understand are commonly held for purposes of cash management.
142

139

See, e.g.,
NVCA Letter.

140
We do not view investing in short-term holdings as being a venture capital strategy; however, for purposes of the exemption, a qualifying fund could invest in short-term holdings as part of implementing its investment strategy.
See also infra
Section II.A.7.

141
Rule 203(l)-1(c)(6).

142

See, e.g.,
NVCA Letter.

The rule defines short-term holdings to include “cash and cash equivalents” by reference to rule 2a51-1(b)(7)(i) under the Investment Company Act.
143

We did not receive any comments on this aspect of the proposal and are adopting it without modification. Rule 2a51-1, however, is used to determine whether an owner of an investment company excluded by reason of section 3(c)(7) of the Investment Company Act meets the definition of a qualified purchaser by examining whether such owner holds sufficient “investments” (generally securities and other assets held for investment purposes).
144

We are not defining a venture capital fund's cash holdings by reference to whether the cash is held “for investment purposes” or to the net cash surrender value of an insurance policy. Furthermore, since rule 2a51-1 does not explicitly include short-term U.S. Treasuries, which we believe would be an appropriate form of cash equivalent for a venture capital fund to hold pending investment in a portfolio company or distribution to investors, our rule includes short-term U.S. Treasuries with a remaining maturity of 60 days or less.
145

143
Rule 2a51-1(b)(7) under the Investment Company Act provides that cash and cash equivalents include foreign currencies “held for investment purposes” and “(i) [b]ank deposits, certificates of deposit, bankers acceptances and similar bank instruments held for investment purposes; and (ii) [t]he net cash surrender value of an insurance policy.” 17 CFR 270.2a51-1(b)(7).

144

See generally
sections 2(a)(51) and 3(c)(7) of the Investment Company Act; 17 CFR 270.2a51-1(b) and (c).

145
We have treated debt securities with maturities of 60 days or less differently than debt securities with longer maturities under our rules. In particular, we have recognized that the potential for fluctuation in those shorter-term securities' market value has decreased sufficiently that, under certain conditions, we allow certain open-end investment companies to value them using amortized cost value rather than market value.
See Valuation of Debt Instruments by Money Market Funds and Certain Other Open-End Investment Companies,
Investment Company Act Release No. 9786 (May 31, 1977) [42 FR 28999 (June 7, 1977)]. We believe that the same consideration warrants treating U.S. Treasury securities with a remaining maturity of 60 days or less as more akin to cash equivalents than Treasuries with longer maturities for purposes of the definition of venture capital fund.

3. Qualifying Portfolio Company

Under the rule, qualifying investments generally consist of equity securities issued by a qualifying portfolio company. A “qualifying portfolio company” is defined as any company that: (i) Is not a reporting or foreign traded company and does not have a control relationship with a reporting or foreign traded company; (ii) does not incur leverage in connection with the investment by the private fund and distribute the proceeds of any such borrowing to the private fund in exchange for the private fund investment; and (iii) is not itself a fund (
i.e.,
is an operating company).
146

We are adopting the rule substantially as proposed, with modifications to the leverage criterion in order to address certain concerns raised by commenters. We describe each element of a qualifying portfolio company below. We understand each of the criteria to be characteristic of issuers of portfolio securities held by venture capital funds.
147

Moreover, collectively, we believe these criteria would operate to exclude most private equity funds and hedge funds from the definition.

146
Rule 203(l)-1(c)(4). In the Proposing Release, we used the defined term “publicly traded” company, but are modifying the rule to use the defined term “reporting or foreign traded” company to match more closely the defined term and to make clear that certain companies that have issued securities that are traded on a foreign exchange are covered by the definition.
See
proposed rule 203(l)-1(c)(3) and (4).

147

See
Proposing Release,
supra
note 26, sections II.A.1.a.-II.A.1.e.

a. Not a Reporting Company

Under the rule, a qualifying portfolio company is defined as a company that, at the time of any investment by a qualifying fund, is not a “reporting or foreign traded” company (a “reporting company”) and does not control, is not controlled by or under common control with, a reporting company.
148

Under the definition, a venture capital fund may continue to treat as a qualifying investment any previously directly acquired equity security of a portfolio company that subsequently becomes a reporting company.
149

Moreover, after a company becomes a reporting company, a qualifying fund could acquire the company's publicly traded (or foreign traded) securities in the secondary markets, subject to the availability of the fund's non-qualifying basket.

148
Rule 203(l)-1(c)(4)(i); rule 203(l)-1(c)(5) (defining a “reporting or foreign traded” company as one that is subject to the reporting requirements under section 13 or 15(d) of the Exchange Act, or has a security listed or traded on any exchange or organized market operating in a foreign jurisdiction). This definition is similar to rule 2a51-1 under the Investment Company Act (defining “public company,” for purposes of the qualified purchaser standard, as “a company that files reports pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934”), and rule 12g3-2 under the Exchange Act (conditioning a foreign private issuer's exemption from registering securities under section 12(g) of the Exchange Act if, among other conditions, the “issuer is not required to file or furnish reports” pursuant to section 13(a) or section 15(d) of the Exchange Act). 17 CFR 270.2a51-1; 17 CFR 240.12g3-2. Under the rule, securities of a “reporting or foreign traded company” include securities of non-U.S. companies that are listed on a non-U.S. market or non-U.S. exchange. Rule 203(l)-1(c)(5).

149
Rule 203(l)-1(c)(4)(i) (defining a qualifying portfolio company as any company that at the time of any investment by a venture capital fund is not a reporting or foreign traded company).

As we discussed in the Proposing Release, venture capital funds provide operating capital to companies in the early stages of their development with the goal of eventually either selling the company or taking it public.
150

Unlike

other types of private funds, venture capital funds are characterized as not trading in the public markets, but may sell portfolio company securities into the public markets once the portfolio company has matured.
151

As of year-end 2010, U.S. venture capital funds managed approximately $176.7 billion in assets.
152

In comparison, as of year-end 2010, the U.S. publicly traded equity market had a market value of approximately $15.4 trillion,
153

whereas global hedge funds had approximately $1.7 trillion in assets under management.
154

The aggregate amount invested in venture capital funds is considerably smaller.
155

Congressional testimony asserted that these funds may be less connected with the public markets and may involve less potential for systemic risk.
156

This appears to be a key consideration by Congress that led to the enactment of the venture capital exemption.
157

As we discussed in the Proposing Release, the rule we proposed sought to incorporate this Congressional understanding of the nature of investments of a venture capital fund, and these principles guided our consideration of the proposed venture capital fund definition.
158

The proposed rule would have required that a qualifying fund invest primarily in equity securities of companies that are not capitalized by the public markets.
159

150

See
Testimony of James Chanos, Chairman, Coalition of Private Investment Companies, July 15, 2009, at 4 (“[V]enture capital funds are an important source of funding for start-up companies or turnaround ventures.”); National Venture Capital Association Yearbook 2010 (“NVCA Yearbook 2010”), at 7-8 (noting that venture capital is a “long-term investment” and the “payoff [to the venture capital firm] comes after the company is acquired or goes public.”); George W. Fenn, Nellie Liang and Stephen Prowse, The Economics of the Private Equity Market, December 1995, 22, n.61 and accompanying text (“Fenn
et al.”
) (“Private sales” are not normally the most important type of exit strategy as compared to IPOs, yet of the 635 successful portfolio company exits by venture capitalists between 1991-1993 “merger and acquisition transactions accounted for 191 deals and IPOs for 444 deals.” Furthermore, between 1983 and 1994, of the 2,200 venture capital fund exits, 1,104 (approximately 50%) were attributed to mergers and acquisitions of venture-backed firms.).
See also
Jack S. Levin, Structuring Venture Capital, Private Equity and Entrepreneurial Transactions, 2000 (“Levin”) at 1-2 to 1-7 (describing the various types of venture capital and private equity investment business but stating that “the phrase `venture capital' is sometimes used narrowly to refer only to financing the start-up of a new

business”); Anna T. Pinedo & James R. Tanenbaum, Exempt and Hybrid Securities Offerings (2009), Vol. 1 at 12-2 (discussing the role initial public offerings play in providing venture capital investors with liquidity).

151

See
Testimony of Trevor Loy, Flywheel Ventures, before the Senate Banking Subcommittee on Securities, Insurance and Investment Hearing, July 15, 2009 (“Loy Testimony”), at 5 (“We do not trade in the public markets.”).
See also
Testimony of Terry McGuire, General Partner, Polaris Venture Partners, and Chairman, National Venture Capital Association, before the U.S. House of Representatives Committee on Financial Services, October 6, 2009 (“McGuire Testimony”) at 11 (“[V]enture capital funds do not typically trade in the public markets and generally limit advisory activities to the purchase and sale of securities of private operating companies in private transactions”); Levin,
supra
note 150, at 1-4 (“A
third
distinguishing feature of venture capital/private equity investing is that the securities purchased are generally privately held as opposed to publicly traded * * * a venture capital/private equity investment is normally made in a privately-held company, and in the relatively infrequent cases where the investment is into a publicly-held company, the [venture capital fund] generally holds non-public securities.”) (emphasis in original).

152
National Venture Capital Association Yearbook 2011 (“NVCA Yearbook 2011”) at 9, Fig. 1.0.

153
Bloomberg Terminal Database, WCAUUS Bloomberg United States Exchange Market Capitalization).

154
Credit Suisse,
2010 Hedge Fund Industry Review,
Feb. 2011 (“Credit Suisse Report”), at 1.

155
In 2010, investors investing in newly formed funds committed approximately $12.3 billion to venture capital funds compared to approximately $85.1 billion to private equity/buyout funds. NVCA Yearbook 2011,
supra
note 152, at 20 at Fig. 2.02. In comparison, hedge funds raised approximately $22.6 billion from investors in 2010. Credit Suisse Report,
supra
note 154, at 1.

156

See
S. Rep. No. 111-176,
supra
note 6, at 74-5 (noting that venture capital funds “do not present the same risks as the large private funds whose advisers are required to register with the SEC under this title [IV]. Their activities are not interconnected with the global financial system, and they generally rely on equity funding, so that losses that may occur do not ripple throughout world markets but are borne by fund investors alone. Terry McGuire, Chairman of the National Venture Capital Association, wrote in congressional testimony that `venture capital did not contribute to the implosion that occurred in the financial system in the last year, nor does it pose a future systemic risk to our world financial markets or retail investors.' ”).
See also
Loy Testimony,
supra
note 151, at 7 (noting the factors by which the venture capital industry is exposed to “entrepreneurial and technological risk not systemic financial risk”); McGuire Testimony,
supra
note 151, at 6 (noting that the “venture capital industry's activities are not interwoven with U.S. financial markets”).
See also
Group of Thirty, Financial Reform: A Framework for Financial Stability, January 15, 2009, at 9 (discussing the need for registration of managers of “private pools of capital that employ substantial borrowed funds” yet recognizing the need to exempt venture capital from registration).

157

See supra
note 156.

158

See
Proposing Release,
supra
note 26, at n.43 and n.60 and following text.

159
Most commenters did not express any objection to our proposed definition of “publicly traded,” although one commenter did disagree with the proposed definition's approach to foreign traded securities. This commenter argued that the proposed rule should be modified to “cover securities that have been publicly offered to investors in a foreign jurisdiction and equity securities that are widely held and traded over-the-counter in a foreign jurisdiction.” Merkl Letter. We decline to adopt this approach because the definition would require us to define what constitutes a “public offering” notwithstanding the laws of foreign regulators and legislatures.

Several commenters asserted that the definition should not exclude securities of reporting companies.
160

Most, however, did not object to the rule's limitation on investments in non-reporting companies, but instead sought a more flexible definition that would include some level of investments in reporting companies under certain conditions. For example, certain commenters supported venture capital fund investments in reporting companies only if, at the time the company becomes a reporting company, the fund continued to hold at least a majority of its original investment made when the company was a non-reporting company.
161

Some of these commenters asserted that public offerings, which trigger reporting requirements under the Federal securities laws, were viewed as an additional financing round, with pre-existing venture investors expected to participate.
162

Alternatively, several commenters recommended that a venture capital fund could limit its investment in reporting companies, such as 15 or 20 percent of the fund's capital commitments.
163

160

See
Bessemer Letter; IVP Letter (also suggested additional conditions); Merkl Letter. One commenter also suggested that the definition should not exclude investments in companies that may be deemed to be “controlled” by a public company (or its venture capital investment division).
See
Comment Letter of Berkeley Center for Law, Business and the Economy (Feb. 1, 2011) (“BCLBE Letter”).
See also
Dechert General Letter (argued that restricting the application of the control element may be necessary because an adviser to a venture capital fund could be controlled by a public company, and might itself be deemed to control a portfolio company as a result of its prior investments). Under our rule, a venture capital fund could invest in such companies under the non-qualifying basket.

161
ATV Letter; BIO Letter; NVCA Letter.
See also
Davis Polk Letter; InterWest Letter; McDonald Letter; Mesirow Letter; PTV Sciences Letter. A number of commenters supported expanding the proposed definition but without additional conditions.
See, e.g.,
BioVentures Letter; ESP Letter; Quaker BioVentures Letter; SV Life Sciences Letter.

162

See, e.g.,
Alta Partners Letter; Gunderson Dettmer Letter; InterWest Letter; McDonald Letter; NVCA Letter; Quaker BioVentures Letter.
See also
Bessemer Letter; BIO Letter; Lowenstein Letter.

163
Alta Partners Letter (supported limiting investments in public companies to 15% of fund capital commitments); Gunderson Dettmer Letter (supported limiting investments in public securities to 20% of fund capital commitments).
See also
Davis Polk Letter (supported limiting investments in public companies to 20% of fund capital commitments provided the fund continues to hold a majority of its original investment in the company when it was private); SVB Letter (supported investments in public securities but did not identify a percentage threshold).

We understand that venture capital funds seek flexibility to invest in promising portfolio companies, including companies deemed sufficiently profitable to become reporting companies or companies that may be owned directly or indirectly by a public company. Rather than modify the rule to impose additional criteria for investing in reporting companies, however, we have adopted a limit of 20 percent for non-qualifying investments, which may be used to hold securities of reporting companies. We believe that the 20 percent limit appropriately balances commenters' expressed desire for greater flexibility to accommodate existing business practices while providing sufficient limits on the extent of investments that would implicate Congressional statements regarding the interconnectedness of venture capital funds with the public markets.
164

164

See supra
Section II.A.1.b. One commenter argued that, in addition to funds that would satisfy the proposed definition, a venture capital fund should include any fund that invests at least 75% of its capital in privately held “domestic small business” as defined in the Small Business Investment Act (the “SBIA”) regulations, regardless of the equity/debt nature of the investment.
See
NASBIC/SBIA Letter. In the Proposing Release, we noted our concerns with adopting a definition for a “small” company, including reliance on the SBIA regulatory standards for treatment as a “small”

company, which generally imposes specific tests for net worth, net income or number of employees for each type of company, depending on its geographic location and industry classification.
See
Proposing Release,
supra
note 26, at n.69 and accompanying and following text. We have considered the issues raised in the NASBIC/SBIA Letter and continue to believe that a qualifying portfolio company should not be defined by reference to whether a company is “small” for the reasons cited in the Proposing Release.

Under our rule, a qualifying portfolio company is defined to include a company that is not a reporting company (and does not have a control relationship with a reporting company) at the time of each fund investment.
165

However, one commenter observed that an existing investment in a portfolio company that ultimately becomes a successful venture capital investment (such as when the company issues its securities in a public offering or becomes a reporting company) should not result in the investment becoming a non-qualifying investment.
166

We agree. Under the rule, such an investment would not become a non-qualifying investment because the definition focuses on the time at which the venture capital fund acquires the particular equity security issued by a portfolio company and does not limit the definition of qualifying portfolio company solely to companies that are and remain non-reporting companies. Under this approach, an adviser could continue to rely on the exemption even if the venture capital fund's portfolio ultimately consisted entirely of securities that become securities of reporting companies. We believe that our approach would give advisers to venture capital funds sufficient flexibility to exercise their business judgment on the appropriate time to dispose of portfolio company investments—whether that occurs at a time when the company is or is not a reporting company.
167

Moreover, under the Federal securities laws, a person, such as a venture capital fund, that is deemed to be an affiliate of a company may be limited in its ability to dispose of the company's securities.
168

Under the final rule, a qualifying fund would not be in the position of having to dispose of securities of a qualifying portfolio company that subsequently becomes a reporting company.

165

See
rule 203(l)-1(c)(4)(i).

166
PTV Sciences Letter (stating that following a merger or public offering of a qualifying portfolio company's securities, the shares held by the fund “are turned into profits to our investors”).

167

See
Proposing Release,
supra
note 26, at n.55 and following text.

168

See
sections 2(a)(11) (defining “underwriter”) and 5 of the Securities Act.
See also
E.H. Hawkins, SEC Staff No-Action Letter (June 26, 1997) (staff explained how the term “underwriter” in the Securities Act restricts resales of securities by affiliates of issuing companies).

b. Portfolio Company Leverage

Rule 203(l)-1 defines a qualifying portfolio company for purposes of the exemption as one that does not borrow or issue debt obligations in connection with the venture capital fund's investment in the company and distribute to the fund the proceeds of such borrowing or issuance in exchange for the fund's investment.
169

As a consequence, certain types of funds that use leverage or finance their investments in portfolio companies or the buyout of existing investors with borrowed money (
e.g.
, leveraged buyout funds, which are a different subset of private equity funds) would not meet the rule's definition of a venture capital fund.
170

As discussed in greater detail below and in the Proposing Release, we believe that Congress did not intend the venture capital fund definition to apply to these types of private equity funds.
171

169
Rule 203(l)-1(c)(4)(ii).

170
Leveraged buyout funds are private equity funds that will “borrow significant amounts from banks to finance their deals—increasing the debt-to-equity ratio of the acquired companies * * *” U.S. Govt. Accountability Office, Private Equity: Recent Growth in Leveraged Buyouts Exposed Risks that Warrant Continued Attention (2008) (“GAO Private Equity Report”), at 1. A leverage buyout fund in 2005 typically financed a deal with 34% equity and 66% debt.
Id.
at 13.
See also
Fenn
et al., supra
note 150, at 23 (companies that have been taken private in a leveraged buyout (or “LBO”) transaction generally “spend less on research and development, relative to assets, and have a greater proportion of fixed assets; their debt-to-assets ratios are high, above 60 percent, and are two to four times those of venture-backed firms.” Moreover, compared to venture capital backed companies, LBO-private equity backed companies that are taken public typically use proceeds from an IPO to reduce debt whereas new venture capital backed firms tend to use proceeds to fund growth.); Testimony of Mark Tresnowksi, General Counsel, Madison Dearborn Partners, LLC, on behalf of the Private Equity Council, before the Senate Banking Subcommittee on Securities, Insurance and Investment, July 15, 2009, at 2 (indicating that portfolio companies in which private equity funds invest typically have 60% debt and 40% equity).

171

See
discussion in section II.A.1.c. and d. of the Proposing Release,
supra
note 26.

We proposed to define a qualifying portfolio company as a company that does not borrow “in connection” with a venture capital fund investment. We also proposed to define a qualifying portfolio company as a company that does not participate in an indirect buyout involving a qualifying fund (as a corollary to our proposed limitation on venture capital fund acquisitions of portfolio company securities through secondary transactions,
i.e.
, direct buyouts).
172

We proposed these elements to distinguish between venture capital funds that provide capital to portfolio companies for operating and business purposes (in exchange for an equity investment) and leveraged buyout funds, which acquire controlling equity interests in operating companies through the “buyout” of existing security holders or which finance such investments or buyouts with borrowed money.
173

We proposed these elements of the qualifying portfolio company definition because of the focus on leverage in the Dodd-Frank Act as a potential contributor to systemic risk as discussed by the Senate Committee report,
174

and the testimony before Congress that stressed the lack of leverage in venture capital investing.
175

172
Proposed rules 203(l)-1(a)(2)(i); (c)(4)(ii) and (c)(4)(iii).

173

See generally
Proposing Release,
supra
note 26, at sections II.A.1.c. and d.

174

See
S. Rep. No. 111-176,
supra
note 6, at 74 (“The Committee believes that venture capital funds, a subset of private investment funds specializing in long-term equity investment in small or start-up businesses, do not present the same risks as the large private funds whose advisers are required to register with the SEC under this title.”);
id.
at 75 (concluding that private equity funds that use limited or no leverage at the fund level engage in activities that do not pose risks to the wider markets through credit or counterparty relationships).

175

See
Proposing Release,
supra
note 26, at n.100.

Some commenters argued that defining a venture capital fund as a fund that does not participate in buyouts was too restrictive or too difficult to apply.
176

Most of the commenters who addressed the issue opposed a definition that excluded any buyouts of portfolio company securities by venture capital funds.
177

Some commenters argued that because a venture capital fund could, under the proposed rule, acquire up to 20 percent of portfolio company securities in secondary transactions, indirect buyouts achieved at the portfolio company level should not be precluded.
178

Some commenters stated that buyouts are an important means of providing liquidity to portfolio company founders, employees, former employees and vendors/service providers,
179

while others argued that

buyouts occurring as a result of recapitalizations
180

or conversions of permissible bridge loans
181

should not preclude a fund from relying on the definition.
182

176

See, e.g.,
McGuireWoods Letter; NVCA Letter; Pine Brook Letter.

177
One commenter sought interpretative guidance on which buyout transactions would be considered to be “in connection with” a venture capital fund investment. Mesirow Letter.
See also
McGuireWoods Letter; NVCA Letter (discussing some interpretative issues with the “in connection with” language).

178
ATV Letter; NVCA Letter.
See also
ABA Letter (also recommending that the buyout bucket be increased to 30%);

Charles River Letter (supported a 20% buyout limit to accommodate the increasing industry use of buyouts); First Round Letter (supported 25% buyout limit for each deal and a 20% limit for all fund investments in order to facilitate liquidity to founders).

179

See, e.g.,
Davis Polk Letter; ESP Letter; SVB Letter.

180
Alta Partners Letter; BioVentures Letter.

181
ATV Letter; NVCA Letter.

182

See also
Pine Brook Letter (suggesting “careful drafting” that would not preclude transactions in the normal course of business by defining a set of prohibited buyout transactions (
e.g.,
“leveraged dividend recapitalizations”)).

We have eliminated the proposed indirect buyout criterion in the final rule. Because the non-qualifying basket does not exclude secondary market transactions (or other buyouts of existing security holders), it would be inconsistent to define a venture capital fund as a fund that does not participate in a buyout.

We are retaining and clarifying, however, the leveraged buyout criterion as it relates to qualifying portfolio companies. We had proposed to define a qualifying portfolio company as a company that, among other things, does not borrow “in connection” with a venture capital fund investment. As noted above, we proposed this element to distinguish venture capital funds from leveraged buyout funds, and we continue to believe that this remains an important distinction. We believe that these differences (
i.e.
, the use of buyouts and associated leverage) distinguish venture capital funds from buyout private equity funds for which Congress did not provide an exemption.
183

183

See supra
note 174 and accompanying text.

One of the distinguishing features of venture capital funds is that, unlike many hedge funds and private equity funds, they invest capital directly in portfolio companies for the purpose of funding the expansion and development of the company's business rather than buying out existing security holders, otherwise purchasing securities from other shareholders, or leveraging the capital investment with debt financing.
184

Testimony received by Congress and our research suggest that venture capital funds provide capital to many types of businesses at different stages of development,
185

generally with the goal of financing the expansion of the company
186

and helping it progress to the next stage of its development through successive tranches of investment (
i.e.
, “follow-on” investments) if the company reaches agreed-upon milestones.
187

184

See
Loy Testimony,
supra
note 151, at 2 (“Although venture capital funds may occasionally borrow on a short-term basis immediately preceding the time when the cash installments are due, they do not use debt to make investments in excess of the partner's capital commitments or `lever up' the fund in a manner that would expose the fund to losses in excess of the committed capital or that would result in losses to counter parties requiring a rescue infusion from the government.”).
See also infra
notes 189-191; Mark Heesen & Jennifer C. Dowling, National Venture Capital Association,
Venture Capital & Adviser Registration
(October 2010), materials submitted in connection with the Commission's Government-Business Forum on Small Business Capital Formation (summarizing the differences between venture capital funds and buyout and hedge funds),
available at http://www.sec.gov/info/smallbus/2010gbforumstatements.htm.

185

See, e.g.,
McGuire Testimony,
supra
note 151, at 1; NVCA Yearbook 2010,
supra
note 150; PricewaterhouseCoopers/National Venture Capital Association MoneyTree Report, Q4 2009/Full-year 2009 Report (providing data on venture capital investments in portfolio companies); James Schell, Private Equity Funds: Business Structure and Operations (2010), at § 1.03[1] (“Schell”), at § 1.03[1];
Paul A. Gompers & Josh Lerner, The Venture Capital Cycle
, at 459 (MIT Press 2004), at 178, 180 table 8.2 (displaying percentage of annual venture capital investments by stage of development and classifying “early stage” as seed, start-up, or early stage and “late stage” as expansion, second, third, or bridge financing).

186

See
McGuire Testimony,
supra
note 151, at 1; Loy Testimony,
supra
note 151, at 3 (“Once the venture fund is formed, our job is to find the most promising, innovative ideas, entrepreneurs, and companies that have the potential to grow exponentially with the application of our expertise and venture capital investment.”).
See also
William A. Sahlman,
The Structure and Governance of Venture-Capital Organizations,
Journal of Financial Economics 27 (1990), at 473, 503 (“Sahlman”) (noting venture capitalists typically invest more than once during the life of a company, with the expectation that each capital investment will be sufficient to take the company to the next stage of development, at which point the company will require additional capital to make further progress).

187

See
Sahlman,
supra
note 186, at 503; Loy Testimony,
supra
note 151, at 3 (“[W]e continue to invest additional capital into those companies that are performing well; we cease follow-on investments into companies that do not reach their agreed upon milestones.”).

In contrast, private equity funds that are identified as buyout funds typically provide capital to an operating company in exchange for majority or complete ownership of the company,
188

generally achieved through the buyout of existing shareholders or other security holders and financed with debt incurred by the portfolio company,
189

and compared to venture capital funds, hold the investment for shorter periods of time.
190

As a result of the use of the capital provided and the incurrence of this debt, following the buyout fund investment, the operating company may carry debt several times its equity and may devote significant levels of its cash flow and corporate earnings to repaying the debt financing, rather than investing in capital improvement or business operations.
191

188
GAO Private Equity Report,
supra
note 170, at 8 (“A private equity-sponsored LBO generally is defined as an investment by a private equity fund in a public or private company (or division of a company) for majority or complete ownership.”).

189

See
Annalisa Barrett
et al.,
Prepared by the Corporate Library Inc., under contract for the IRRC Institute, What is the Impact of Private Equity Buyout Fund Ownership on IPO Companies' Corporate Governance?, at 7 (June 2009) (“Barrett
et al.”
) (“In general, VC firms provide funding to companies in early stages of their development, and the money they provide is used as working capital for the firm. Buyout firms, in contrast, work with mature companies, and the funds they provide are used to compensate the firm's existing owners.”); Ieke van den Burg and Poul Nyrup Rasmussen, Hedge Funds and Private Equity: A Critical Analysis (2007), at 16-17 (“van den Burg”); Sahlman,
supra
note 186, at 517.
See also
Tax Legislation: CRS Report, Taxation of Hedge Fund and Private Equity Managers
,
Tax Law and Estate Planning Course Handbook Series, Practicing Law Institute (Nov. 2, 2007) at 2 (noting that in a leveraged buyout “private equity investors use the proceeds of debt issued by the target company to acquire all the outstanding shares of a public company, which then becomes private”).

190
Unlike venture capital funds, which generally invest in portfolio companies for 10 years or more, private equity funds that use leveraged buyouts invest in their portfolio companies for shorter periods of time.
See
Loy Testimony,
supra
note 151, at 3 (citing venture capital fund investments periods in portfolio companies of five to 10 years or longer); van den Burg,
supra
note 189, at 19 (noting that LBO investors generally retain their investment in a listed company for 2 to 4 years or even less after the company goes public).
See also
Paul A. Gompers,
The Rise and Fall of Venture Capital,
Business And Economic History, vol. 23, no. 2, Winter 1994, at 17 (stating that “an LBO investment is significantly shorter than that of a comparable venture capital investment. Assets are sold off almost immediately to meet debt burden, and many companies go public again (in a reverse LBO) in a very short period of time.”).

191

See
Barrett
et al., supra
note 189.
See also
Fenn
et al., supra
note 150, at 23 (companies that have been taken private in an LBO transaction generally “spend less on research and development, relative to assets, and have a greater proportion of fixed assets; their debt-to-assets ratios are high, above 60%, and are two to four times those of venture-backed firms.” Moreover, compared to venture capital backed companies, LBO-private equity backed companies that are taken public typically use proceeds from an IPO to reduce debt whereas new venture capital backed firms tend to use proceeds to fund growth.).

Some commenters agreed that distinguishing between venture capital and other private funds with reference to a portfolio company's leverage and indirect buyouts is important.
192

Many commenters, however, urged a more narrowly drawn restriction on a portfolio company's ability to borrow (or issue debt) or to effect indirect buyouts.
193

Some argued that the manner in which proceeds from indebtedness are used by a portfolio company (
e.g.
, distributed by the company to the venture capital fund) better distinguishes venture capital funds from leveraged buyout private equity funds.
194

Nevertheless, the majority of commenters who addressed this criterion supported a leverage criterion that would be more specific, or

limited, in scope,
195

focusing on the use of proceeds derived from portfolio company leverage.
196

Commenters suggested that the rule define leverage as leverage incurred for the purpose of buying out shareholders at the demand of the venture capital fund
197

or for returning capital to the fund,
198

and not, for example, define leverage to include indebtedness incurred to pay for a qualifying portfolio company's operating expenses.
199

192

See, e.g.,
AFL-CIO Letter; Sen. Levin Letter; Pine Brook Letter.

193

See, e.g.,
ATV Letter; Charles River Letter; NVCA Letter; Oak Investment Letter; Pine Brook Letter.

194

See, e.g.,
NVCA Letter; Pine Brook Letter; SV Life Sciences Letter; Vedanta Letter.

195

See, e.g.,
ATV Letter; Charles River Letter (supports modifying the rule so that up to 20% of fund capital commitments may be invested in portfolio companies that do not adhere to the leverage condition provided that the venture capital fund is not the party providing the leverage to the company); NVCA Letter; Comment Letter of the Securities Regulation Committee of the Business Law Section of the New York State Bar Association, Apr. 1, 2011 (“NYSBA Letter”); SVB Letter.

196
Although two commenters supported the leverage limitation as proposed (
see
AFL-CIO Letter (also supporting a specific prohibition on borrowing by a portfolio company to pay dividends or fees to the venture capital fund); Sen. Levin Letter (together with the equity investment requirement, the definition appropriately excludes leveraged buyout funds)), two other commenters opposed it, arguing that qualifying portfolio company leverage should not be restricted at all (
see
ESP Letter (limits on leverage would prevent portfolio companies from receiving lending from venture debt funds and state governments and lenders rather than regulators should determine the appropriate level of portfolio company debt); Merkl Letter (young negative EBITDA companies would not be able to obtain significant amounts of debt and hence no leverage prohibition is required)).
See also
NASBIC/SBIA Letter (portfolio companies should not be precluded from accessing leverage); Sevin Rosen Letter, Pine Brook Letter (each expressed support for a use of proceeds approach).

197

See, e.g.,
Gunderson Dettmer Letter; McDonald Letter; NVCA Letter; SVB Letter.

198

See, e.g.,
McDonald Letter; NVCA Letter.

199
Gunderson Dettmer Letter; Pine Brook Letter; Trident Letter; Vedanta Letter. One commenter suggested that a use of proceeds test would be difficult to enforce because such a test would need to be extremely detailed in order to prevent circumvention.
See
Merkl Letter.

Some commenters argued that the proposed “in connection with” element would be difficult to apply, arguing that the standard was too vague or raised too many interpretative issues.
200

In response to our request for comment, many commenters sought confirmation that the limitation on portfolio company leverage would be triggered only in the instances of leverage provided to the portfolio company by the venture capital fund or if portfolio company borrowing were effected in satisfaction of a contractual obligation with the venture capital fund.
201

200

See, e.g.,
Merkl Letter; Sevin Rosen Letter; SVB Letter.

201

See, e.g.,
ABA Letter; ATV Letter; Bessemer Letter; Mesirow Letter; NVCA Letter; SV Life Sciences Letter.
See also
Proposing Release,
supra
note 26, discussion at section II.A.1.c.

After careful consideration of the intended purpose of th

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2011-16118. Public record. Not legal advice.