[Federal Register Volume 75, Number 237 (Friday, December 10, 2010)]
[Proposed Rules]
[Pages 77190-77227]
[FR Doc No: 2010-29957]

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 275

[Release No. IA-3111; 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: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (the ``Commission'') is
proposing rules that would implement new exemptions from the
registration requirements of the Investment Advisers Act of 1940 for
advisers to certain privately offered investment funds that 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 would define ``venture capital fund'' and
provide for an exemption for advisers with less than $150 million in
private fund assets under management in the United States. The new
rules would also clarify the meaning of certain terms included in a new
exemption for foreign private advisers.

DATES: Comments should be received on or before January 24, 2011.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to<EMAIL_ADDRESS>Please include
File Number S7-37-10 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Elizabeth M. Murphy,
Secretary, Securities and Exchange Commission, 100 F Street, NE.,
Washington, DC 20549-1090.

All submissions should refer to File Number S7-37-10. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments
are also available for Web site viewing and printing in the
Commission's Public Reference Room, 100 F Street, NE., Washington, DC
20549, on official business days between the hours of 10 a.m. and 3
p.m. All comments received will be posted without change; we do not
edit personal identifying information from submissions. You should
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Tram N. Nguyen, Daniele Marchesani, or
David A. Vaughan, at<PHONE_NUMBER> 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 requesting public comment
on proposed 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) (``Advisers Act'').\1\
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    \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).
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Table of Contents

I. Background
II. Discussion
    A. Definition of Venture Capital Fund
    1. Qualifying Portfolio Companies
    2. Management Involvement
    3. Limitation on Leverage
    4. No Redemption Rights
    5. Represents Itself as a Venture Capital Fund
    6. Is a Private Fund
    7. Other Factors
    8. Application to Non-U.S. Advisers
    9. 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
    5. Transition Rule
    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. Request for Comment
IV. Paperwork Reduction Act Analysis
V. Cost-Benefit Analysis
VI. Regulatory Flexibility Act Certification
VII. Statutory Authority
Text of Proposed Rules

I. Background

    On July 21, 2010, President Obama signed into law the Dodd-Frank
Act,\2\ which amends various provisions of the Advisers Act and
requires or authorizes the Commission to adopt several new rules and
revise existing rules.\3\ Unless otherwise provided for in the Dodd-
Frank Act, the amendments become effective on July 21, 2011.\4\
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    \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\ Section 419 of the Dodd-Frank Act.
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    The amendments include the repeal of section 203(b)(3) of the
Advisers Act, which exempts any investment adviser from registration if
the investment adviser (i) Has had fewer than 15 clients in the
preceding 12 months, (ii) does not hold itself out to the public as an
investment adviser and (iii) does 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'').\5\
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.\6\
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    \5\ 15 U.S.C. 80b-3(b)(3) as in effect before July 21, 2011.
    \6\ See section 204(a) of the Advisers Act. See also infra note
30.
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    The primary purpose of Congress in repealing section 203(b)(3) was
to

require advisers to ``private funds'' to register under the Advisers
Act.\7\ 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 \8\ (``Investment Company Act'') by reason of sections 3(c)(1)
or 3(c)(7) of such Act.\9\ Section 3(c)(1) is available to a fund that
does not publicly offer the securities it issues \10\ and has 100 or
fewer beneficial owners of its outstanding securities.\11\ A fund
relying on section 3(c)(7) cannot publicly offer the securities it
issues \12\ and generally must limit the owners of its outstanding
securities to ``qualified purchasers.'' \13\
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    \7\ 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, infra note 39.
    \8\ 15 U.S.C. 80a.
    \9\ 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.''
    \10\ Interests in a private fund may be offered pursuant to an
exemption from registration under the Securities Act of 1933 (15
U.S.C. 77a) (``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'').
    \11\ 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.'').
    \12\ See supra note 10.
    \13\ 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.
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    Each of these types of private funds advised by an adviser
typically qualifies as a single client for purposes of the private
adviser exemption.\14\ As a result, investment advisers could form up
to 14 private funds, regardless of the total number of investors
investing in the funds, without the need to register with us.\15\ This
has permitted the growth of unregistered investment advisers with large
amounts of assets under management and significant numbers of investors
but without the Commission oversight that registration under the
Advisers Act provides.\16\ Concern about this lack of Commission
oversight led us to adopt a rule in 2004 extending registration to
hedge fund advisers,\17\ which was vacated by a federal court in
2006.\18\ In Title IV of the Dodd-Frank Act (``Title IV''), Congress
has now generally extended Advisers Act registration to advisers to
hedge funds and many other private funds by eliminating the current
private adviser exemption.\19\
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    \14\ See rule 203(b)(3)-1(a)(2).
    \15\ 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).
    \16\ See generally id. (noting that the private adviser
exemption contributed to growth in the number and size of, and
investor participation in, hedge funds).
    \17\ 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'').
    \18\ Goldstein v. Securities and Exchange Commission, 451 F.3d
873 (D.C. Cir. 2006) (``Goldstein'').
    \19\ Section 403 of the Dodd-Frank Act amends existing section
203(b)(3) of the Advisers Act by repealing the current private
adviser exemption and inserting the 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.
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    In addition to removing the broad exemption provided by section
203(b)(3), Congress created three exemptions from registration under
the Advisers Act.\20\ These new exemptions apply to: (i) Advisers
solely to venture capital funds, without regard to the number of such
funds advised by the adviser or the size of such funds; \21\ (ii)
advisers solely to private funds with less than $150 million in assets
under management in the United States, without regard to the number or
type of private funds advised; \22\ and (iii) non-U.S. advisers with
less than $25 million in aggregate assets under management from U.S.
clients and private fund investors and fewer than 15 such clients and
investors.\23\
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    \20\ 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 proposed a rule
defining ``family office'' in a prior release (Family Offices,
Investment Advisers Act Release No. 3098 (Oct. 12, 2010) [75 FR
63753 (Oct. 18, 2010)]).
    \21\ See section 407 of the Dodd-Frank Act (exempting advisers
solely to ``venture capital funds,'' as defined by the Commission).
    \22\ 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).
    \23\ See section 402 of the Dodd-Frank Act (defining ``foreign
private adviser'' as ``any investment adviser who--(A) Has no place
of business in the United States; (B) has, in total, fewer than 15
clients and investors in the United States in private funds advised
by the investment adviser; (C) has aggregate assets under management
attributable to clients in the United States and investors in the
United States in private funds advised by the investment adviser of
less than $25,000,000, or such higher amount as the Commission may,
by rule, deem appropriate in accordance with the purposes of this
title; and (D) neither--(i) Holds itself out generally to the public
in the United States as an investment adviser; nor (ii) acts as--(I)
an investment adviser to any investment company registered under the
Investment Company Act of 1940 [15 U.S.C. 80a]; or a company that
has elected to be a business development company pursuant to section
54 of the Investment Company Act of 1940 (15 U.S.C. 80a-53), and has
not withdrawn its election.'').
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II. Discussion

    Today we are proposing three rules that would implement these
exemptions.\24\ In a separate companion release (the ``Implementing
Release''),\25\ we are proposing 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.\26\
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    \24\ The Commission provided the public with an opportunity to
present its views on various rulemaking and other initiatives that
the Dodd-Frank Act required the Commission to undertake. Public
views relating to our rulemaking in connection with the exemptions
for certain advisers addressed in this Release are available at
http://www.sec.gov/comments/df-title-iv/exemptions/exemptions.shtml.
    \25\ Rules Implementing Amendments to the Investment Advisers
Act of 1940, Investment Advisers Act Release No. 3110 (Nov. 19,
2010).
    \26\ See infra note 30 and accompanying and following text.
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    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 and directs the Commission to
define ``venture capital fund'' within one year of enactment.\27\ We
are proposing new rule 203(l)-1 to provide such a definition, which we
discuss below in Section II.A of this Release.
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    \27\ See supra note 21.
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    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.\28\ We are proposing such an
exemption in a new rule 203(m)-1, which we discuss below in Section
II.B of this Release. Proposed rule 203(m)-1 includes provisions for
determining the amount of an adviser's private fund assets for purposes
of the exemption and when those assets are deemed managed in the United
States.
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    \28\ See supra note 22.
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    The new exemptions under sections 203(l) and 203(m) provide that
the Commission shall require advisers relying on them to provide the
Commission with reports and keep records as the Commission determines
necessary or appropriate in the public interest or for the protection
of investors.\29\ These new exemptions do not limit our statutory
authority to examine the books and records of advisers relying upon
these exemptions.\30\ For purposes of this Release we will refer to
these advisers as ``exempt reporting advisers.'' In the Implementing
Release, we are proposing reporting requirements for exempt reporting
advisers.\31\
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    \29\ See supra notes 21 and 22.
    \30\ 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 section 203(l) or 203(m) of the Advisers
Act 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.
    \31\ See Implementing Release, supra note 25, at section II.B.
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    The third exemption, set forth in amended section 203(b)(3) of the
Advisers Act, provides an exemption from registration for certain
foreign private advisers. New section 202(a)(30) of the Advisers Act
defines ``foreign private adviser'' 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,\32\ and less than $25 million in aggregate
assets under management from such clients and investors.\33\ As
discussed in Section II.C of this Release, in order to clarify the
application of this new exemption, we are proposing a new rule
202(a)(30)-1, which would define a number of terms included in the
statutory definition of foreign private adviser.\34\
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    \32\ Subparagraph (B) of section 202(a)(30) refers to 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).
    \33\ 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 prevent an
adviser that advises a business development company from relying on
the exemption.
    \34\ Proposed rule 202(a)(30)-1 would define the following
terms: (i) ``client;'' (ii) ``investor;'' (iii) ``in the United
States;'' (iv) ``place of business;'' and (v) ``assets under
management.'' See discussion infra in section II.C of this Release.
We are proposing rule 202(a)(30)-1 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.
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    These exemptions are not mandatory. 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 from registering with the
Commission most advisers that do not have at least $100 million in
assets under management.\35\ An adviser choosing to avail itself of the
exemptions under sections 203(l), 203(m) or 203(b)(3), however, may be
subject to registration by one or more state securities
authorities.\36\
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    \35\ 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, and 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 from
registering with the Commission an investment adviser that has
assets under management between $25 million and $100 million if 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 Release, supra note 25, at section II.A.
    \36\ See section 203A(b)(1) of the Advisers Act (exempting from
state regulatory requirements only advisers registered with the
Commission). See also infra note 265 (discussing the application of
section 222 of the Advisers Act).
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A. Definition of Venture Capital Fund

    We are proposing a definition of ``venture capital fund'' for
purposes of the new exemption for investment advisers that advise
solely venture capital funds.\37\ Proposed rule 203(l)-1 would define
the term venture capital fund consistently with what we believe
Congress understood venture capital funds to be, and in light of other
provisions of the federal securities laws that seek to achieve similar
objectives.\38\
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    \37\ See proposed rule 203(l)-1.
    \38\ See infra notes 94, 123, 125 (discussing the history of and
regulatory framework applicable to business development companies
under federal securities laws).
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    We understand that Congress sought to distinguish advisers to
``venture capital funds'' from the larger category of advisers to
``private equity funds'' for which Congress considered, but ultimately
did not provide, an exemption.\39\ As a general matter, venture capital
funds are long-term investors in early-stage or small companies that
are privately held, as distinguished from other types of private equity
funds, which may invest in businesses at various stages of development
including mature, publicly held companies.\40\ Testimony received by
Congress characterized venture capital funds as typically contributing
substantial capital to early-stage companies \41\ and generally not

leveraged,\42\ and thus not contributing to systemic risk, a factor
that appears significant to Congress' determination to exempt these
advisers.\43\ In drafting the proposed rule, we have 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.
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    \39\ While the Senate voted to exempt private equity fund
advisers in addition to venture capital fund advisers, the final
Dodd-Frank Act only exempts venture capital fund advisers. Compare
Restoring American Financial Stability Act of 2010, S. 3217, 111th
Cong. Sec.  408 (2010) (as passed by the Senate) with Dodd-Frank
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.
    \40\ See Testimony of Trevor Loy, Flywheel Ventures, before the
Senate Banking Subcommittee on Securities, Insurance and Investment
Hearing, July 15, 2009 (``Loy Testimony''), at 3; Testimony of James
Chanos, Chairman, Coalition of Private Investment Companies, July
15, 2009, at 4 (``Chanos Testimony'') (``Private investment
companies play significant, diverse roles in the financial markets
and in the economy as a whole. For example, venture capital funds
are an important source of funding for start-up companies or
turnaround ventures. Other private equity funds provide growth
capital to established small-sized companies, while still others
pursue `buyout' strategies by investing in underperforming companies
and providing them with capital and/or expertise to improve
results.''); 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 (``Tresnowski Testimony'') (stating
that private equity firms invest in broad categories of companies,
including ``struggling and underperforming businesses'' and ''
promising or strong companies''). See also Preqin, Private Equity
and Alternative Asset Glossary, http://www.preqin.com/itemGlossary.aspx?pnl=UtoZ (defining venture capital as ``a type of
private equity investment that provides capital to new or growing
businesses. Venture funds invest in start-up firms and small
businesses with perceived, long-term growth potential.'').
    \41\ Loy Testimony, supra note 40, at 3; 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, at
3 (``McGuire Testimony'') (``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. Often these companies are
formed from ideas and entrepreneurs that come out of university and
government laboratories--or even someone's garage.''). See also
National Venture Capital Association 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'') (``NVCA Yearbook 2010''); Private Equity Growth
Capital Council, Private Equity: Frequently Asked Questions, http://www.privateequitycouncil.org/just-the-facts/private-equity-frequently-asked-questions/ (noting that venture capital funds focus
on ``start-up and young companies with little or no track record,''
whereas buyout and growth funds focus on more mature businesses).
    \42\ Loy Testimony, supra note 40, at 3. See also McGuire
Testimony, supra note 41, at 3-4 (``most limited partnership
agreements [of venture capital funds] * * * prohibit [the venture
capital fund] from any type of long term borrowing. * * * Leverage
is not part of the equation because start-ups do not typically have
the ability to sustain debt interest payments and often do not have
collateral that lenders desire. In fact most of our companies are
not profitable and require our equity to fund their losses through
their initial growth period.'').
    \43\ See S. Rep. No. 111-176, supra note 7, 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
40, at 7 (noting the factors by which the venture capital industry
is exposed to ``entrepreneurial and technological risk not systemic
financial risk'').
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    This is not the first time that Congress has included special
provisions to the federal securities laws for these types of private
funds and the advisers that advise them. In 1980, in an effort to
promote capital raising by small businesses,\44\ Congress provided
exemptions from various requirements in the Investment Company Act and
Advisers Act for ``business development companies'' (or ``BDCs'').\45\
Congress adopted the term BDC to avoid ``semantical disagreements''
over what constituted a venture capital or small business company,\46\
but acknowledged that the purpose of the BDC provisions was to support
``venture capital'' activity in capital formation for small
businesses.\47\ The BDC provisions and venture capital exemption
reflect many similar policy considerations, and thus in drafting the
definition of ``venture capital fund,'' we have looked, in part, to
language Congress previously used to describe these types of funds.
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    \44\ See H. Rep. No. 96-1341, at 21-22 (1980) (``1980 House
Report'').
    \45\ See infra note 123 for a discussion of these definitions.
    \46\ See 1980 House Report, supra note 44, at 22.
    \47\ See id., at 21.
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    As described in more detail below, we propose to define a venture
capital fund as a private fund that: (i) Invests in equity securities
of private companies in order to provide operating and business
expansion capital (i.e., ``qualifying portfolio companies,'' which are
discussed below) and at least 80 percent of each company's securities
owned by the fund were acquired directly from the qualifying portfolio
company; (ii) directly, or through its investment advisers, offers or
provides significant managerial assistance to, or controls, the
qualifying portfolio company; (iii) does not borrow or otherwise incur
leverage (other than limited short-term borrowing); (iv) does not offer
its investors redemption or other similar liquidity rights except in
extraordinary circumstances; (v) represents itself as a venture capital
fund to investors; and (vi) is not registered under the Investment
Company Act and has not elected to be treated as a BDC.\48\ We also
propose to grandfather an existing fund as a venture capital fund if it
satisfies certain criteria under the grandfathering provision.\49\ An
adviser would be eligible to rely on the exemption under section 203(l)
of the Advisers Act (the ``venture capital exemption'') only if it
solely advised venture capital funds that met all of the elements of
the proposed definition or if it were grandfathered.
---------------------------------------------------------------------------

    \48\ Proposed rule 203(l)-1(a).
    \49\ Proposed rule 203(l)-1(b).
---------------------------------------------------------------------------

1. Qualifying Portfolio Companies
    We propose to define a venture capital fund for the purposes of the
exemption as a fund that invests in equity securities issued by
``qualifying portfolio companies,'' which we define generally as any
company that: (i) Is not publicly traded; (ii) does not incur leverage
in connection with the investment by the private fund; (iii) uses the
capital provided by the fund for operating or business expansion
purposes rather than to buy out other investors; and (iv) is not itself
a fund (i.e., is an operating company).\50\ In addition to equity
securities, the venture capital fund may also hold cash (and cash
equivalents) and U.S. Treasuries with a remaining maturity of 60 days
or less.\51\ We understand each of the criteria to be characteristic of
issuers of portfolio securities held by venture capital funds.\52\
Moreover, collectively, these criteria would operate to exclude most
other private equity funds and hedge funds from the definition. We
describe each element of a qualifying portfolio company below.
---------------------------------------------------------------------------

    \50\ Proposed rule 203(l)-1(c)(4).
    \51\ Proposed rule 203(l)-1(a)(2).
    \52\ See infra sections II.A.1.a-II.A.1.e of this Release.
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a. Private Companies
    We propose to define a venture capital fund as a fund that invests
in equity securities of qualifying portfolio companies and cash and
cash equivalents and U.S. Treasuries with a remaining maturity of 60
days or less.\53\ At the time of each investment by the venture capital
fund, the portfolio company could not be publicly traded nor could it
control, be controlled by, or be under common control with, a publicly
traded company.\54\ Under the proposed definition, a venture capital
fund could continue to hold securities of a portfolio company that
subsequently becomes public.
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    \53\ Proposed rule 203(l)-1(a)(2).
    \54\ Proposed rule 203(l)-1(c)(4)(i); proposed rule 203(l)-
1(c)(3) (defining a ``publicly 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). Under the proposed rule,
securities of a publicly traded company, as defined, would include
securities of non-U.S. companies that are listed on a non-U.S.
market or non-U.S. exchange. Some securities that are ``pink
sheets'' (i.e., generally over-the-counter securities that are
quoted on an electronic quotation system operated by Pink OTC
Markets) are not subject to the reporting requirements under
sections 13 and 15(d) of the Exchange Act and would not be publicly
traded for purposes of the proposed rule.
---------------------------------------------------------------------------

    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.\55\ Unlike

other types of private funds, venture capital funds do not trade in the
public markets, but may sell portfolio company securities into the
public markets once the portfolio company has matured.\56\ As of year-
end 2009, U.S. venture capital funds managed approximately $179.4
billion in assets.\57\ In comparison, as of year-end 2009, the U.S.
publicly traded equity market had a market value of approximately $13.7
trillion,\58\ whereas global hedge funds had approximately $1.4
trillion in assets under management.\59\ As a consequence, the
aggregate amount invested in venture capital funds is considerably
smaller, and Congressional testimony asserted that these funds may be
less connected with the public markets and may involve less potential
for systemic risk.\60\ This appears to be a key consideration by
Congress that led to the enactment of the venture capital
exemption.\61\
---------------------------------------------------------------------------

    \55\ See Chanos Testimony, supra note 40, at 4 (``[V]enture
capital funds are an important source of funding for start-up
companies or turnaround ventures.''); NVCA Yearbook 2010, supra note
41, 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 (``Pinedo'')
(discussing the role initial public offerings play in providing
venture capital investors with liquidity).
    \56\ See Loy Testimony, supra note 40, at 5 (``We do not trade
in the public markets.''). See also McGuire Testimony, supra note
41, 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 55, 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).
    \57\ NVCA Yearbook 2010, supra note 41, at 9.
    \58\ Bloomberg Terminal Database, WCAUUS (Bloomberg United
States Exchange Market Capitalization).
    \59\ See Saijel Kishan, Hedge Funds Hold Investors ``Hostage''
After Decade's Best Year, Bloomberg Businessweek, Jan. 20, 2010,
available at http://www.businessweek.com/news/2010-01-20/hedge-funds-hold-investors-hostage-after-decade-s-best-year.html.
    \60\ See supra note 43; McGuire Testimony, supra note 41, 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).
    \61\ See supra note 43.
---------------------------------------------------------------------------

    We request comment on our proposed approach. We considered more
narrow definitions, such as defining a qualifying portfolio company as
a ``start-up company'' or ``small company.'' \62\ There appears to be
little consensus, however, as to what a start-up company is. A company
may be considered a ``start-up'' business depending on when it was
formed as a legal entity,\63\ whether it employs workers or paid
employment taxes,\64\ or whether it has generated revenues.\65\
Defining a portfolio company based on any one of these factors may
inadvertently exclude too many start-up portfolio companies. For
example, solely relying on the age of the company (e.g., first year
since incorporation) fails to recognize that many companies may be
incorporated for some period of time prior to initiating business
operations or remain unincorporated for significant periods of
time.\66\ Likewise, payment of employment taxes assumes the hiring of
employees, despite the fact that many new business ventures are sole
proprietorships without employees.\67\ Such a test could also have the
unintended effect of discouraging hiring. Similarly, a bright-line
revenue test set too low could exclude young or new businesses that
generate significant revenues more quickly than other companies.\68\
This could have the unintended consequence of venture capital funds
that seek to fall within the definition investing in less promising,
non-revenue generating, young companies.
---------------------------------------------------------------------------

    \62\ See S. Rep. No. 111-176, supra note 7, at 74 (describing
venture capital funds as a subset of private investment companies,
specializing in long-term equity investments in ``small or start-up
businesses'').
    \63\ There is no generally accepted definition of a ``start-up''
entity although it is generally used to refer to new business
ventures. See, e.g., U.S. Census Bureau, Business Dynamics
Statistics, available at http://www.ces.census.gov/index.php/bds/bds_overview (which tracks information on businesses, based on the
size and age of the business, and assigns a ``birth'' year to a
business beginning in the year in which it reports positive
employment of workers on the payroll); The Kauffman Foundation,
Where Will the Jobs Come From?, November 2009, at 5 (identifying
``start-ups'' as those firms younger than one year); Anastasia Di
Carlo & Roger Kelly, Private Equity Market Outlook 27 (European
Investment Fund, Working Paper 2010/005) (defining start-ups as
companies that are ``in the process of being set up or may have been
in business for a short time, but have not sold their product
commercially'').
    \64\ See, e.g., The Kauffman Foundation, An Overview of the
Kauffman Firm Survey, Results from the 2004-2008 Data, May 2010, at
26 (``Overview of the Kauffman Firm Survey'') (discussing the
difficulties of compiling data on new businesses; start-up
businesses were generally identified based on several factors: the
payment of state unemployment taxes, the payment of Federal
Insurance Contributions Act taxes, the existence of a legal entity,
use of an employer identification number, and use of a schedule C to
report business income on a personal tax return).
    \65\ See, e.g., NVCA Yearbook 2010, supra note 41, at 61, 69,
111 (not defining ``start-up'' but classifying investments in
``start-up/seed'' companies and defining the ``seed stage'' of a
company as ``the state of a company when it has just been
incorporated and its founders are developing their product or
service,'' whereas an ``early stage'' company is one that is beyond
the ``seed stage'' but has not yet generated revenues). Cf.
PricewaterhouseCoopers MoneyTree Report Definitions, https://www.pwcmoneytree.com/MTPublic/ns/nav.jsp?page=definitions (last
visited Sept. 23, 2010) (defining a ``seed/start-up'' company as one
that has a concept or product in development but not yet operational
and usually has been in existence for less than 18 months).
    \66\ According to the Kauffman Survey, in 2004, 36.0% of all
start-up companies were sole proprietorships; by 2008, 34.4% of all
surviving companies were sole proprietorships. Overview of the
Kauffman Firm Survey, supra note 64, at 8.
    \67\ See, e.g., Ying Lowrey, Startup Business Characteristics
and Dynamics: A Data Analysis of the Kauffman Firm Survey, Aug.
2009, at 6 (Working Paper) (based on a survey sample of businesses
started in 2004, reporting that 59% of all start-up companies in
2004 had zero employees; a ``start-up'' business was any business
that met any one of the five following criteria for being a start-
up: the payment of state unemployment taxes, the payment of Federal
Insurance Contributions Act taxes, the existence of a legal entity,
use of an employer identification number, and use of a schedule C to
report business income on a personal tax return).
    \68\ According to the Kauffman Survey, which conducted a
longitudinal study of ``start-up'' businesses that began in 2004,
46.5% of all such ``start-up'' companies in 2004 had zero revenues;
by 2008, 30.2% of the surviving companies in the sample reported
zero revenues. In comparison, in 2004, 15.3% of start-up companies
reported revenues of more than $100,000 and in 2008, 36.1% of the
surviving companies in the survey reported revenues of more than
$100,000. Overview of the Kauffman Firm Survey, supra note 64, at 9.
---------------------------------------------------------------------------

    We also considered defining a qualifying portfolio company as a
small company. As in the case of defining ``start-up,'' there is no
single definition for what constitutes a ``small company.'' \69\ We are
concerned that

imposing a 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. As in the case of
adopting a revenue-based test, there is the potential that even a low
threshold for a size metric could inadvertently restrict venture
capital funds from funding otherwise promising young small companies.
---------------------------------------------------------------------------

    \69\ Among countries that are members of the Organisation for
Economic Co-operation and Development, ``small and medium-sized
enterprises'' (``SMEs'') are defined as non-subsidiary, independent
firms employing fewer than the number of employees as is set by each
country. The definition of SME may be used to determine funding or
other programs sponsored by member countries. Although the European
Union generally defines SMEs as businesses with fewer than 250
employees, the United States sets the threshold at fewer than 500
employees. Moreover, ``small'' firms are generally defined as those
with fewer than 50 employees, while micro-enterprises have at most
10, or in some cases five, workers. In 2005, the European Union
adopted additional tests for small businesses, defining small
business (i.e., 10-49 employees) as those with no more than [euro]10
million in annual revenue and no more than [euro]10 million in
assets as evidenced on their annual balance sheet. See, e.g.,
Organisation for Economic Co-operation and Development, Glossary of
Statistical Terms, http://stats.oecd.org/glossary/detail.asp?ID=3123.
     Under one regulatory framework in the United States, a business
may be considered ``small'' depending on the specified number of
employees or the net worth or net income of such business. Separate
tests are specified for a business based on various factors, such as
the size of the industry, its geographical concentration, and the
number of market participants. See, e.g., Small Business
Administration, SBA Size Standards Methodology (Apr. 2009) at 8,
http://www.sba.gov/idc/groups/public/documents/sba_homepage/size_standards_methodology.pdf (noting that the Small Business
Administration (``SBA'') decided to apply the net worth and net
income measures to its Small Business Investment Company (``SBIC'')
financing program because investment companies typically evaluate
businesses using these measures when determining whether or not to
invest). For example, under the SBIC program administered by the
SBA, SBA loans may be made to SBICs that invest in companies that
are ``small'' (usually defined as having a net worth of $18 million
or less and an average after-tax net income for the prior two years
of no more than $6 million, although there are specific tests
depending on the industry of the company that may be based on net
income, net worth or number of employees). The size requirement is
codified at 13 CFR 121.301(c)(2). See SBA, Investment Program
Summary, http://www.sba.gov/financialassistance/borrowers/vc/sbainvp/index.html.
---------------------------------------------------------------------------

    Other tests also present concerns. A test adopted by the California
Corporations Commission and the U.S. Department of Labor requires that
a venture capital company hold at least 50 percent of its assets in
``operating companies,'' which are defined as companies primarily
engaged in the production or sale of a product or services other than
the investment of capital.\70\ Under the California exemption, a
venture capital fund could invest in older and more mature companies
that qualify as ``operating companies'' as well as in securities issued
by publicly traded companies provided that the venture capital fund
obtained management rights in such publicly traded companies.\71\
Hence, although the California venture capital exemption is for
advisers to so-called ``venture capital companies,'' the rule provides
a much broader exemption that would include many types of private
equity and other types of private funds and thus does not appear
consistent with our understanding of the intended scope of section
203(l).\72\ We request comment on any of these approaches or
alternative ones that we have not discussed.\73\
---------------------------------------------------------------------------

    \70\ Under section 260.204.9 of the California Code of
Regulations (the ``California VC exemption''), an adviser is exempt
from the requirement to register if it provides investment advice
only to ``venture capital companies,'' which are generally defined
as entities that, on at least one annual occasion (commencing with
the first annual period following the initial capitalization), have
at least 50% of their assets (other than short-term investments
pending long-term commitment or distribution to investors), valued
at cost, in ``venture capital investments.'' A venture capital
investment is defined as an acquisition of securities in an
operating company as to which the adviser has or obtains management
rights. See Cal. Code Regs. tit. 10, Sec.  260.204.9(a), (b)(3),
(b)(4) (2010). An ``operating company'' is defined to mean any
entity ``primarily engaged, directly or through a majority owned
subsidiary or subsidiaries, in the production or sale (including any
research or development) of a product or service other than the
management or investment of capital but shall not include an
individual or sole proprietorship.'' Id. tit. 10, Sec.
260.204.9(b)(7). ``Management rights'' is defined as the ``right,
obtained contractually or through ownership of securities . . . to
substantially participate in, to substantially influence the conduct
of, or to provide (or offer to provide) significant guidance and
counsel concerning, the management, operations or business
objectives of the operating company in which the venture capital
investment is made.'' Id. tit. 10, Sec.  260.204.9(b)(6). Management
rights may be held by the adviser, the fund or an affiliated person
of the adviser, and may be obtained either through one person or
through two or more persons acting together. Id.
     The U.S. Department of Labor regulations (``VCOC exemption'')
are similar to the California VC exemption. The regulations define
``operating company'' to mean an entity that is ``primarily engaged,
directly or through a majority owned subsidiary or subsidiaries, in
the production or sale of a product or service other than the
investment of capital. The term `operating company' includes an
entity that is not described in the preceding sentence, but that is
a `venture capital operating company' described in paragraph (d) or
a `real estate operating company' described in paragraph (e).'' 29
CFR 2510.3-101(c)(1). The regulations define a venture capital
operating company (``VCOC'') as 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). A venture
capital investment is defined as ``an investment in an operating
company (other than a venture capital operating company) as to which
the investor has or obtains management rights'' that are
``contractual rights * * * to substantially participate in, or
substantially influence the conduct of, the management of the
operating company.'' 29 CFR 2510.3-101(d)(3).
    \71\ See Cal. Code Reg. tit. 10, Sec.  260.204.9.
    \72\ The California VC exemption does not limit permitted
investments to companies that are start-up or privately held
companies, which were cited as characteristic of venture capital
investing in testimony to Congress. See McGuire Testimony, supra
note 41; Loy Testimony, supra note 40.
    \73\ See Letter of Keith P. Bishop (July 28, 2009) (recommending
elements of the California VC exemption). Cf. Letter of P. James
(August 21, 2010) (expressing the view that the provision of
management services does not distinguish venture capital from
private equity). We received these letters in response to our
request for public views on rulemaking and other initiatives under
the Dodd-Frank Act. See generally supra note 24.
---------------------------------------------------------------------------

    We also request comment on our approach to ``follow-on''
investments.\74\ Under our proposed rule, a qualifying portfolio
company is defined to include a company that is not publicly traded (or
controlled by a publicly traded company) at the time of each fund
investment,\75\ but would not exclude a portfolio company that
ultimately becomes a successful venture capital investment (typically
when the company is taken ``public''). Under this approach, an adviser
could continue to rely on the exemption even if the venture capital
fund's portfolio ultimately consisted entirely of publicly traded
securities, a result that could be viewed as inconsistent with section
203(l) of the Advisers Act. We believe that our proposed 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--which may occur at a time when the
company is privately held or publicly held.\76\ Moreover, under the
federal securities laws, a person that is deemed to be an affiliate of
a publicly traded company may be limited in its ability to dispose of
publicly traded securities.\77\ Would our proposed approach to follow-
on investments accommodate the way venture capital funds typically
invest? Are there circumstances in which a venture capital fund would
provide follow-on investments in a company that has become public?
Should the rule specifically provide that a venture capital fund
includes a fund that invests a limited percentage of its capital in
publicly traded securities under certain circumstances (e.g., a follow-
on investment in a company in which the fund's previous investments
were made when the company was private)? If so, what is the appropriate
percentage threshold (e.g., 5, 10 or 20 percent)?
---------------------------------------------------------------------------

    \74\ See, e.g., Loy Testimony, supra note 40, at 3 (discussing
the role of follow-on investments); NVCA Yearbook 2010, supra note
41, at 34 (statistics comparing initial investments versus follow-on
investments made by venture capital funds at Figure 3.15).
    \75\ See proposed rule 203(l)-1(c)(4)(i).
    \76\ See supra note 55.
    \77\ See, e.g., rule 144 under the Securities Act (17 CFR
230.144) (prohibiting the resale of certain restricted and control
securities by ``affiliates'' unless certain conditions are met).
---------------------------------------------------------------------------

    We request comment on whether our definition should exclude any
venture capital fund that holds any publicly traded securities or a
specified percentage of publicly traded portfolio

company securities. What percentage would be appropriate? What
percentage would give venture capital funds sufficient flexibility to
dispose of their publicly traded securities? Would 30 or 40 percent of
the value of a venture capital fund's assets be appropriate? \78\
Should the rule specify that publicly traded securities may only be
held for a limited period of time, such as one-year, or that a venture
capital fund's entire portfolio may not consist only of publicly traded
securities except for a limited period of time, such as one-year or
other period?
---------------------------------------------------------------------------

    \78\ Cf. note 94 (discussing limits applicable to BDCs).
---------------------------------------------------------------------------

b. Equity Securities, Cash and Cash Equivalents and Short-Term U.S.
Treasuries.
    We propose to define venture capital fund for purposes of the
exemption as a fund that invests in equity securities of qualifying
portfolio companies, cash and cash equivalents and U.S. Treasuries with
a remaining maturity of 60 days or less.\79\ Under our proposed
definition, a fund would not qualify as a venture capital fund for
purposes of the exemption if it invested in debt instruments (unless
they met the definition of ``equity security'') of a portfolio company
or otherwise lent money to a portfolio company, strategies that are not
the typical form of venture capital investing.\80\ Congress received
testimony that, unlike other types of private funds, venture capital
funds ``invest cash in return for an equity share of the company's
stock.'' \81\ As a consequence, venture capital funds avoid using
financial leverage, and leverage appears to have raised systemic risk
concerns for Congress.\82\ Should our definition of venture capital
fund include funds that invest in debt, or certain types of debt,
issued by qualifying portfolio companies, or make certain types of
loans to qualifying portfolio companies? We understand that some
venture capital funds may extend ``bridge'' financing to portfolio
companies in anticipation of a future round of venture capital
investment.\83\ Such financings may take the form of investment in
instruments that are ultimately convertible into a portfolio company's
common or preferred stock at a subsequent investment stage and thus
would meet the definition of ``equity security.'' \84\ Should our
definition include any fund that extends bridge financing that does not
meet the definition of ``equity security'' on a short-term limited
basis to a qualifying portfolio company? Should our definition be
limited to those funds that make bridge loans to a portfolio company
that are convertible into equity funding only in the next round of
venture capital investing? Under our proposed definition, debt
investments or loans with respect to qualifying portfolio companies
that did not meet the definition of ``equity security'' could not be
made by a fund seeking to qualify as a venture capital fund. Should we
modify the proposed rule so that such investments and loans could be
made subject to a limit? If so, what would be an appropriate limit
(e.g., 5 or 10 percent) and how should the limit be determined (e.g.,
as a percentage of the fund's capital commitments)?
---------------------------------------------------------------------------

    \79\ Proposed rule 203(l)-1(a)(2).
    \80\ See Loy Testimony, supra note 40, at 2, 4; Pinedo, supra
note 55, Vol. 1 at 12-2; Levin, supra note 55, at 1-5 (noting that
venture capital funds focus on ``common stock or common equivalent
securities, with any purchase of subordinated debentures and/or
preferred stock generally designed merely to fill a hole in the
financing or to provide [the venture capitalist] with some priority
over management in liquidation or return of capital''). See also
Jesse M. Fried and Mira Ganor, Agency Costs of Venture Capitalist
Control in Startups, 81 N.Y.U. Law Journal 967, 970 (2006) (venture
capital funds investing in U.S. start-ups ``almost always receive
convertible preferred stock''); Fenn et al., supra note 55, at 32.
    \81\ McGuire Testimony, supra note 41, at 4; Loy Testimony,
supra note 40, at 2.
    \82\ See infra section II.A.3 of this Release.
    \83\ See, e.g., Darian M. Ibrahim, Debt as Venture Capital, 4 U.
Ill. L. Rev. 1169, 1173, 1206 (2010) (``VCs sometimes [provide]
bridge loans to their portfolio companies * * * [A] bridge loan * *
* is [essentially] about `funding to subsequent rounds of equity'
rather than relying on the underlying start-up's ability to repay
the loan through cash flows.''); Alan Olsen, Venture Capital
Financing: Structure and Pricing, VirtualStreet (July 25, 2010),
available at http://www20.csueastbay.edu/news/2010/07/alan-olsen-venture-capital.html (``Bridge financing is designed as temporary
financing in cases where the company has obtained a commitment for
financing at a future date, which funds will be used to retire the
debt.''); Thomas Flynn, Venture Capital: Current Trends and Lessons
Learned, Ventures and Intellectual Property Letter (2003), available
at http://www.shipmangoodwin.com/publications/Detail.aspx?pub=194
(``The bridge financing, intended to take the cash strapped company
either to the next full round of venture investment or alternatively
to a liquidity event or wind-up, has become a familiar fixture in
the life cycle of a venture-backed company.'').
    \84\ Provided such financings were structured to satisfy the
definition of equity security, we would view such transactions to
satisfy the definition of qualifying portfolio company under
proposed rule 203(l)-1(c)(4)(ii).
---------------------------------------------------------------------------

    We propose to use the definition of equity security in section
3(a)(11) of the Securities Exchange Act of 1934 (``Exchange Act'') and
rule 3a11-1 thereunder.\85\ This definition is broad, and includes
common stock as well as preferred stock, warrants and other securities
convertible into common stock in addition to limited partnership
interests.\86\ This definition would include various securities in
which venture capital funds typically invest and would provide venture
capital funds with flexibility to determine which equity securities in
the portfolio company capital structure are appropriate for the
fund.\87\ We request comment on the use of this definition. Should we
consider a more limited definition of equity security? Do venture
capital funds typically invest in other types of equity securities that
are not covered by the proposed definition?
---------------------------------------------------------------------------

    \85\ 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.'').
    \86\ See rule 3a11-1 under the Exchange Act (17 CFR 240.3a11-1)
(defining ``equity security'' to include any ``limited partnership
interest'').
    \87\ Our proposed 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. See supra note 80. Our
proposed definition 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 investors.
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    Under the proposed rule, we define a venture capital fund for
purposes of the exemption as a fund that holds cash and cash
equivalents or short-term U.S. Treasuries, in recognition of the manner
in which venture capital funds operate.\88\ A venture capital fund may
hold cash funded by its investors until the cash is allocated to an
investment opportunity; subsequently, upon liquidation of the
investment, the venture capital fund will receive cash as a return on
its investment, which is then distributed to the fund's investors.\89\

Thus, pending receipt of all capital commitments from investors or
pending distribution of such proceeds to investors, a venture capital
fund could hold cash and cash equivalents and short-term U.S.
Treasuries.\90\ We define ``cash and cash equivalents'' by reference to
rule 2a51-1(b)(7)(i) under the Investment Company Act.\91\ 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).\92\ We do not propose to define 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 would include short-term U.S. Treasuries with a
remaining maturity of 60 days or less among the investments a venture
capital fund could hold.\93\ Should we specify a shorter or longer
period of remaining maturity for U.S. Treasuries?
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    \88\ Proposed rule 203(l)-1(a)(2)(ii).
    \89\ ``[T]he capital supplied to a venture capital fund consists
entirely of equity commitments provided as cash from investors in
installments on an as-needed basis. * * * The `capital calls' for
investments generally happen in cycles over the full life of the
fund on an `as needed' basis as investments are identified by the
general partners and then as further rounds of investment are made
into the portfolio companies.'' Loy Testimony, supra note 40, at 2;
Paul A. Gompers & Josh Lerner, The Venture Capital Cycle, at 459
(MIT Press 2004) (``Gompers & Lerner'') (``Venture capitalists can
liquidate their position in the company by selling shares on the
open market and then paying those proceeds to investors in cash.'').
    \90\ Proposed rule 203(l)-1(a)(2)(ii).
    \91\ 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).
    \92\ See generally sections 2(a)(51) and 3(c)(7) of the
Investment Company Act; 17 CFR 270.2a51(b) and (c).
    \93\ 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.
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    We request comment on whether the proposed rule's provision for
cash holdings is too broad or too narrow. Should the rule only specify
that cash be held in anticipation of investments, or in connection with
the payment of expenses or liquidations from underlying portfolio
companies? Are there other types of cash instruments in which venture
capital funds typically invest and/or that should be reflected in the
proposed rule?
    We do not propose to define venture capital fund for purposes of
the exemption as one that invests solely in U.S. companies. In
contrast, the BDC provisions in the Investment Company Act generally
limit the exemption to U.S. companies and require that permitted
investments generally be made in U.S. companies.\94\ However, as we
discuss below, there is no indication in the legislative record that
Congress intended the venture capital exemption would be available only
to U.S. advisers or to advisers that invest fund assets solely in U.S.
companies.\95\ Should our proposed definition similarly define a
venture capital fund as a fund formed under the laws of the United
States and/or that invests exclusively or primarily in U.S. portfolio
companies or a sub-set of such companies (e.g., U.S. companies
operating in non-financial sectors)? Are venture capital funds that
invest in non-U.S. portfolio companies more or less likely to have
financial relationships that may pose systemic risk issues, a rationale
that was presented and appeared significant to Congress in exempting
advisers to venture capital funds?
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    \94\ See sections 2(a)(46) and 2(a)(48) of the Investment
Company Act. Under section 55 of the Investment Company Act, a BDC
is prohibited from acquiring any assets, except for permitted
assets, unless, at the time the acquisition is made, permitted
assets ``represent at least 70 per centum of the value of [the
BDC's] total assets.'' Permitted assets for this purpose generally
mean securities of an ``eligible portfolio company,'' which is
defined in section 2(a)(46) of the Investment Company Act.
    \95\ See infra section II.A.8 of this Release.
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c. Portfolio Company Leverage
    Proposed rule 203(l)-1 would define a qualifying portfolio company
for purposes of the exemption as one that does not borrow, issue debt
obligations or otherwise incur leverage in connection with the venture
capital fund's investments.\96\ 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 proposed rule's definition of a
venture capital fund.\97\ As discussed in greater detail below, we
believe that Congress did not intend the venture capital fund
definition to apply to these other types of private equity funds.\98\
This definition of qualifying portfolio company would only exclude
companies that borrow in connection with a venture capital fund's
investment, but would not exclude companies that borrow in the ordinary
course of their business (e.g., to finance inventory or capital
equipment, manage cash flows, and meet payroll). We would generally
view any financing or loan (unless it met the definition of equity
security) to a portfolio company that was provided by, or was a
condition of a contractual obligation with, a fund or its adviser as
part of the fund's investments as being a type of financing that is
``in connection with'' the fund's investment, although we recognize
that other types of financings may also be ``in connection with'' a
fund's investment. Should we provide guidance on other types of
financing transactions as being ``in connection with'' a fund's
investment in a qualifying portfolio company? If so, what types of
financing transactions should such guidance address? We propose this
element 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,\99\ and the
testimony

before Congress that stressed the lack of leverage in venture capital
investing.\100\ Should we use a test other than whether the loan is
``in connection with'' the fund's investments? For example, should the
test be whether the portfolio company currently intends to borrow at
the time of the fund's investment? Should the test depend only on how
the portfolio company uses the proceeds of borrowing, such as by
excluding companies that use proceeds to buyout investors or return
capital to a fund?
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    \96\ Proposed rule 203(l)-1(c)(4)(ii) (setting forth this
requirement as a condition for the portfolio company to qualify as a
``qualifying portfolio company'').
    \97\ A leveraged buyout fund is a private equity fund 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 55, 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.); Tresnowski
Testimony, supra note 40, at 2 (indicating that portfolio companies
in which private equity funds invest typically have 60% debt and 40%
equity).
    \98\ See infra discussion in section II.A.1.d of this Release.
    \99\ See S. Rep. No. 111-176, supra note 7, 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 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).
    \100\ See Loy Testimony, supra note 40, at 6 (noting that ``many
venture capital funds significantly limit borrowing''). See also
McGuire Testimony, supra note 41, at 7 (``Not only are our
partnerships run without debt but our portfolio companies are
usually run without debt as well.'').
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    Venture capital has been described as investing in companies that
cannot borrow from the usual lending sources.\101\ Should we define a
qualifying portfolio company as a company that does not incur certain
specified types of borrowing or other forms of leverage? Would such a
definition narrow the current range of portfolio companies in which
venture capital funds typically invest?
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    \101\ See Loy Testimony, supra note 40, at 3. See also James
Schell, Private Equity Funds: Business Structure and Operations
(2010), at Sec.  1.03[1] (``Schell'') (``Venture Capital Funds
provide investment capital to business enterprises early in their
development cycle at a time when access to conventional financing
sources is non-existent or extremely limited.'').
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d. Capital Used for Operating and Business Purposes
    Under proposed rule 203(l)-1, a venture capital fund is defined as
a fund that holds equity securities of qualifying portfolio companies,
and at least 80 percent of each company's equity securities owned by
the venture capital fund were acquired directly from each such
qualifying portfolio company.\102\ This element reflects the
distinction 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 ``buy
out'' of existing security holders. Hence, in addition to the
definitional element that a venture capital fund is one that does not
redeem or repurchase securities from other shareholders (i.e., a
``buyout''), a related criterion in the rule specifies that a
qualifying portfolio company is one that does not distribute company
assets to other security holders in connection with the venture capital
fund's investment in the company (which could be an indirect
buyout).\103\
---------------------------------------------------------------------------

    \102\ Proposed rule 203(l)-1(a)(2)(i).
    \103\ Proposed rule 203(l)-1(c)(4)(iii).
---------------------------------------------------------------------------

    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.\104\ Testimony received by Congress and our research suggest
that venture capital funds provide capital to many types of businesses
at different stages of development,\105\ generally with the goal of
financing the expansion of the company \106\ 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.\107\
---------------------------------------------------------------------------

    \104\ See Loy Testimony, supra note 40, 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 109-111; Mark
Heesen & Jennifer C. Dowling, National Venture Capital Association,
Venture Capital & Adviser Registration, materials submitted in
connection with the Commission's Government-Business Forum on Small
Business Capital Formation (``Heesen'') (summarizing the differences
between venture capital funds and buyout and hedge funds), available
at http://www.sec.gov/info/smallbus/2010gbforumstatements.htm.
    \105\ See, e.g., McGuire Testimony, supra note 41, at 1; NVCA
Yearbook 2010, supra note 41; PricewaterhouseCoopers/National
Venture Capital Association MoneyTree Report, Q4 2009/Full-year 2009
Report (providing data on venture capital investments in portfolio
companies); Schell, supra note 101, at Sec.  1.03[1]; Gompers &
Lerner, supra note 89, 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).
    \106\ See McGuire Testimony, supra note 41, at 1; Loy Testimony,
supra note 40, 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).
    \107\ See Sahlman, at 503; Loy Testimony, supra note 40, 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,\108\ generally achieved
through the buyout of existing shareholders or other security holders
and financed with debt incurred by the portfolio company,\109\ and
compared to venture capital funds, hold the investment for shorter
periods of time.\110\ 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.\111\
---------------------------------------------------------------------------

    \108\ GAO Private Equity Report, supra note 97, 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.'').
    \109\ 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 106, 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'').
    \110\ 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 40, at 3
(citing venture capital fund investments periods in portfolio
companies of five to 10 years or longer); van den Burg, 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 (``Gompers'') (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'').
    \111\ See Barrett et al., supra note 109. See also Fenn et al.,
supra note 55, at 23 (when comparing venture capital backed
companies that are taken public to LBO-private equity backed
companies that are taken public, the common use of proceeds from an
IPO are used by LBO-private equity backed companies to reduce debt
whereas new firms use proceeds to fund growth).

---------------------------------------------------------------------------

    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.\112\ Under our proposed rule, an exempt adviser relying on
section 203(1) of the Advisers Act would not be eligible for the
exemption if it advised these types of private equity funds that in
effect acquire a majority of the equity securities of portfolio
companies directly from other security holders.\113\ Correspondingly,
we also propose to define a qualifying portfolio company for purposes
of the exemption as one that does not redeem or repurchase outstanding
securities in connection with a venture capital fund's investment.\114\
Because at least 80 percent of each portfolio company's equity
securities in which the fund invests must be acquired directly from the
portfolio company, a venture capital fund relying on the exemption
could purchase the remainder of the securities directly from existing
shareholders (i.e., a ``buyout''). Under our proposed definition,
however, a company that achieves an indirect buyout of its security
holders, such as through the complete recapitalization or restructuring
of the portfolio company capital structure would not be a qualifying
portfolio company.\115\ The 80 percent test is not intended to preclude
conversions of directly acquired securities into other equity
securities. Similarly, we would not view a capital reorganization
intended merely to simplify a qualifying portfolio company's capital
structure and outstanding securities without any change in the existing
beneficial owners' rights, priority, or economic terms as breaching the
80 percent condition.
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    \112\ See supra notes 39, 42, 43, 99 and accompanying text.
    \113\ Proposed rule 203(l)-1(a)(2)(i).
    \114\ Proposed rule 203(l)-1(c)(4)(iii).
    \115\ For example, concurrently with the issuance of new
securities to the venture capital fund, a portfolio company could
redeem existing shareholders and use proceeds from the venture
capital fund investment to pay such shareholders redemption
proceeds. Similarly, existing shareholders may receive new
securities that are subordinated to the securities issued to the
venture capital fund in exchange for tendering their outstanding
securities, partially funded with investments received from the
venture capital fund. In each of these examples, the fund becomes a
majority owner of the company by ``buying out'' the existing owners
with investment capital initially provided by the fund.
---------------------------------------------------------------------------

    We propose to define a venture capital fund by reference to
ownership of equity securities of a qualifying portfolio company,
wherein at least 80 percent of the securities owned were acquired
directly from the company, in order to give venture capital funds
relying on the exemption some flexibility to acquire securities from a
portfolio company founder or ``angel'' investor who may seek liquidity
from his or her initial investment.\116\ We adopted this 80 percent
threshold because we understand that many venture capital funds
currently are managed in a manner that seeks to rely on provisions of
the tax code providing favorable tax treatment for directly acquired
equity securities of issuers that satisfy certain conditions.\117\
Thus, using this threshold in our definition may not result in
substantial changes to either investment strategies employed, or the
compliance programs currently used, by venture capital advisers. Is our
assumption that venture capital funds do not generally acquire
portfolio company securities directly from existing shareholders
correct? Is 80 percent the appropriate threshold? Should the threshold
be set lower? Should direct acquisitions of equity securities be
increased to 90 percent or 100 percent in order to more effectively
prevent advisers to funds engaged in activities that are not
characteristic of venture capital funds from relying on the exemption?
---------------------------------------------------------------------------

    \116\ See NVCA Yearbook 2010, supra note 41, at 57 (defining
``angel'' as ``a wealthy individual that invests in companies in
relatively early stages of development''). See also Fenn et al.,
supra note 55, at 2 (defining angel capital as ``investments in
small, closely held companies by wealthy individuals, many of whom
have experience operating similar companies [and] * * * may have
substantial ownership stakes and may be active in advising the
company, but they generally are not as active as professional
managers in monitoring the company and rarely exercise control.'').
    \117\ See Int. Rev. Code Sec.  1202(e)(1)(A) (26 U.S.C. 1202)
(``IRC 1202'') (which permits partial exclusion from income tax gain
on directly acquired equity securities of certain issuers that,
among other things, devote at least 80% of their assets to the
conduct of their business as specified in IRC 1202). Under our
proposed rule, at least 80% of the portfolio company securities
owned by a venture capital fund must be acquired directly from the
portfolio company, which in turn cannot redeem or repurchase
existing security holders in connection with such venture capital
fund investment. Thus we presume that venture capital funding
proceeds (or at least 80% of such proceeds) will be used for
operating and business expansion purposes, which is similar to the
requirements under IRC 1202.
---------------------------------------------------------------------------

    In contrast to leveraged buyout fund financing, venture capital
received by a portfolio company is devoted to developing the company's
business rather than repurchasing the securities of other shareholders
or making payments to fund debt financing through the portfolio
company. We request comment on this criterion. Does the definition's
focus on a portfolio company's use of capital received from a venture
capital fund impose any unnecessary burdens on the company's operation
or business? Rather than define a venture capital fund by reference to
the manner in which it acquires equity securities (or the manner in
which qualifying portfolio companies may indirectly facilitate a
buyout), should the proposed rule instead define the manner in which
proceeds from a venture capital investment may be used? For example,
should the rule specify that proceeds of borrowings or other financings
not be used to finance the acquisition of equity securities by a
venture capital fund or otherwise distribute company assets to equity
owners? Would defining qualifying portfolio company in this manner
facilitate compliance or would this approach make it easier for a
company to achieve a ``buyout'' and thereby circumvent the intended
scope of the exemption, given the fungibility of cash and the privately
negotiated nature of typical venture capital transactions? We do not
intend that a venture capital fund would not meet the proposed
definition if it acquired equity securities from a portfolio company in
connection with a capital reorganization intended to simplify the
company's capital structure without changing the existing beneficial
owners' rights, priority, or economic terms. Are there other capital
reorganizations that would be consistent with the intent of our
proposed rule but that would prevent a venture capital fund from
satisfying the proposed definition?
e. Operating Companies
    Proposed rule 203(l)-1 would define the term qualifying portfolio
company for the purposes of the exemption to exclude any private fund
or other pooled investment vehicle.\118\ There is no indication that
Congress intended the venture capital exemption to apply to funds of
funds. Without this definition, a venture capital fund could circumvent
the intended scope of the exemption by investing in other pooled
investment vehicles that are not themselves subject to the definitional
criteria under our proposed rule. For example, a venture capital fund
could circumvent the intent of the proposed rule by incurring off-
balance sheet leverage or indirectly investing in companies that may be
publicly traded. Our proposed exclusion would be similar to the
approach of other

definitions of ``venture capital'' discussed above, which limit
investments to operating companies and thus would exclude investments
in other private funds or securitized asset vehicles.\119\ We request
comment on this definitional element. Under the proposed definition, a
venture capital fund would not invest in another private fund, a
commodity pool or other ``investment companies.'' Should the proposed
definition specifically identify other types of pooled investment
vehicles (e.g., real estate funds or structured investment vehicles) in
which a fund seeking to satisfy the proposed definition could not
invest?
---------------------------------------------------------------------------

    \118\ Proposed rule 203(l)-1(c)(4)(iv). For this purpose, pooled
investment vehicles include investment companies, investment
companies relying on rule 3a-7 under the Investment Company Act and
commodity pools.
    \119\ See California VC exemption, supra notes 70-72; see also
VCOC exemption under 29 CFR 2510.3-101(d), supra note 70.
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1. Management Involvement
    To qualify as a venture capital fund under our proposed definition,
the fund or its investment adviser would: (i) Have an arrangement under
which it offers to provide significant guidance and counsel concerning
the management, operations or business objectives and policies of the
portfolio company (and, if accepted, actually provides the guidance and
counsel) or (ii) control the portfolio company.\120\ Because a key
distinguishing characteristic of venture capital investing is the
assistance beyond the mere provision of capital, we propose that
advisers seeking to rely on the rule have a significant level of
involvement in developing a fund's portfolio companies.\121\ Managerial
assistance generally takes the form of active involvement in the
business, operations or management of the portfolio company, or less
active forms of control of the portfolio company, such as through board
representation or similar voting rights.\122\ We also acknowledge that
the nature of managerial assistance may evolve over time as the needs
of qualifying portfolio companies change, and hence the proposed rule
does not specify that managerial assistance has a fixed character.
---------------------------------------------------------------------------

    \120\ Proposed rule 203(l)-1(a)(3). Under section 202(a)(12) of
the Advisers Act, ``control'' is defined to mean ``the power to
exercise a controlling influence over the management or policies of
a company, unless such power is solely the result of an official
position with such company.''
    \121\ See McGuire Testimony, supra note 41, at 1 (``[W]e build
companies by actively partnering with each entrepreneur and
management team to help propel their ideas into market leading
businesses. We do this by providing a small amount of capital and a
large amount of operating expertise and strategic counsel over a
long period of time. While providing capital is the first order of
business, it is the least time consuming of all our activities. We
also recruit and attract employees at all levels [for the portfolio
company]. We identify and structure strategic partnerships. We raise
additional equity to help the [portfolio] company make it to the
next milestone. And, we're available 24/7 to support great teams,
solve problems, identify opportunities and detect `land mines.' * *
* We provide access to [our] expertise and network at all stages of
a [portfolio] company's development and across all strategic areas
of the business.''). See also Levin, supra note 55, at 1-3 (noting
that the ``first feature distinguishing venture capital/private
equity investing is the VC professional's active involvement in
identifying the investment, negotiating and structuring the
transaction, and monitoring the portfolio company after the
investment has been made. Often, the VC professional will serve as a
board member and/or financial advisor to the portfolio company.
Hence, venture capital/private equity investing is significantly
different from passive selection and retention of stock and debt
investments by a money manager.'') (emphasis in original); Sahlman,
supra note 106, at 508 (noting that venture capitalists typically
play a role in the operation of the company, help to establish
tactics and strategy, work with suppliers and customers, and often
assume more direct control by changing management and sometimes
taking over day-to-day operations themselves). See also Fenn et al.,
supra note 55, at 32-33 for a discussion of various control
mechanisms available to venture capital and private equity funds,
including preferred stock ownership, representation on the board and
various contractual covenants.
    \122\ See generally supra note 121. See also Alan T. Frankel, et
al., Venture Capital: Financial and Tax Considerations, The CPA
Journal (Aug. 2003) at 1 (noting that the ``VC will also monitor the
portfolio company after the investment has been made. Oftentimes,
the VC will serve as a board member or financial and strategic
advisor to the portfolio company.'').
---------------------------------------------------------------------------

    We have modeled the proposed approach to managerial assistance in
part on existing provisions under the Advisers Act and the Investment
Company Act dealing with BDCs, which were added over the years to ease
the regulatory burdens on venture capital and other private equity
investments.\123\ In 1980, when Congress first introduced BDCs into the
Advisers Act and Investment Company Act, it acknowledged that the
purpose of the BDC provisions was to support ``venture capital''
activity in capital formation for small business, and described BDCs as
principally investing in and providing managerial assistance to small,
growing and financially troubled businesses.\124\ Because Congress
modeled the definition of BDC under the Advisers and Investment Company
Acts on the capital formation activities of venture capital funds, both
definitions under such Acts incorporate the requirement to make
available significant managerial assistance to portfolio
companies.\125\
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    \123\ The term ``business development company'' was first
introduced into the Investment Company Act and the Advisers Act in
1980 as part of the Small Business Investment Incentive Act of 1980
(``Small Business Act''), and was amended as part of the National
Securities Markets Improvement Act of 1996, Public Law 104-290, 110
Stat. 3416 (1996) (``NSMIA''). Congress introduced an alternative
regulatory framework applicable to BDCs, which was designed to
remove ``unnecessary disincentives'' for BDCs to provide capital to
small businesses, while also preserving protection for investors and
preventing fraud and abuse. See 1980 House Report, supra note 44, at
21-22.
     In the Small Business Act, Congress modeled the definition of a
BDC under section 202(a)(22) of the Advisers Act on the capital
formation activities of venture capital funds. Congress recognized
that the principal activity of a BDC is to invest in and provide
managerial assistance to small, growing and financially troubled
companies. See 1980 House Report, supra note 44, at 21. See also
infra note 129 (definition of ``making available significant
managerial assistance'' by a BDC under section 2(a)(47) of the
Investment Company Act).
    \124\ See 1980 House Report, supra note 44, at 21.
    \125\ See section 202(a)(22) of the Advisers Act; section
2(a)(48)(B) of the Investment Company Act. Generally, a BDC under
the Advisers Act is any company that meets the definition of BDC
under the Investment Company Act, except that certain requirements
were modified for ``private'' BDCs under the Advisers Act. See also
Prohibition of Fraud by Advisers to Certain Pooled Investment
Vehicles; Accredited Investors in Certain Private Investment
Vehicles, Investment Advisers Act Release No. 2576 (Dec. 27, 2006)
[72 FR 400 (Jan. 4, 2007)] (``Accredited Natural Person Release''),
at n.69 (discussing the difference between the term BDC under the
Investment Company Act and the Advisers Act). In 1996, as part of
NSMIA, Congress sought to encourage greater investment in small
businesses by giving BDCs more flexibility, and therefore expanded
the class of eligible portfolio companies in which BDCs could invest
without being required to provide ``managerial assistance.'' See S.
Rep. No. 104-293, at 13 (1996).
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    Congress did not use the existing BDC definitions when determining
the scope of the venture capital exemption,\126\ and the primary policy
considerations that led to the adoption of the BDC exemptions differed
from those under the Dodd-Frank Act. However, we believe these
provisions are instructive because they reflect many of the same
characteristics of venture capital and private equity fund activity
presented in testimony before Congress in connection with the Dodd-
Frank Act.\127\ Although Congress viewed BDC activities as typical of
``venture capital'' investing,\128\ the BDC provisions are complex.
Hence, we are proposing a modified version of the definition of
``making available significant managerial assistance'' in order to
simplify the language and to reduce the potential for confusion that

might arise in interpreting the meaning of the term.
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    \126\ We have looked to the BDC definition to define a venture
capital fund before. In 2006, we proposed to impose a qualification
standard for all investors of private investment funds, excluding
venture capital funds, which we proposed to define by reference to
section 202(a)(22) of the Advisers Act. See Accredited Natural
Person Release, supra note 125 (proposing to define the term
``accredited natural person'' as any natural person who satisfies
the requirements in Regulation D as an accredited investor and who
also owns investments of at least $2.5 million). We sought
additional comment on this proposal in a subsequent release but a
rule has not been adopted. See Revisions of Limited Offering
Exemptions in Regulation D, Securities Act Release No. 8828 (Aug. 3,
2007) [72 FR 45116 (Aug. 10, 2007)].
    \127\ See generally Loy Testimony, supra note 40; McGuire
Testimony, supra note 41.
    \128\ See 1980 House Report, supra note 44, at 21-2.
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    We request comment on the approach to managerial assistance in the
definition of venture capital fund. As we have noted above,
Congressional testimony asserted that a key characteristic of venture
capital funds is the provision of managerial assistance. Is this true
in the industry generally? We request comment on the description of
managerial assistance in proposed rule 203(l)-1. Is this description
easier to understand and apply than the definition in section 2(a)(47)
of the Investment Company Act? \129\ As under the definition of BDC in
the Advisers and Investment Company Acts, the proposed definition
specifies the fund or its adviser need only offer assistance. Should
the rule specify that the fund or its adviser actually provide
assistance? If so, what if a portfolio company that initially accepts
the offer of assistance later refuses any actual or further assistance?
We understand that when venture capital funds invest as a group, there
may be an understanding among the funds and the portfolio company that
while all fund advisers may be available to provide managerial
assistance if necessary, one adviser is generally expected to provide
most, if not all, of the assistance to the portfolio company. Is that
understanding correct? Under proposed rule 203(l)-1, venture capital
funds that invest as a group would only satisfy the definition if each
venture capital fund (or its adviser) offered (and, if accepted,
provided) managerial assistance or exercised control.\130\ Should the
rule specify how managerial assistance or control is to be determined
in the case of venture capital funds that invest as a group if only one
fund (or its adviser) provides the assistance? Should the rule specify
the extent to which each fund (or its adviser) must offer or provide
managerial assistance or adopt the approach of other regulatory
definitions of ``venture capital'' funds, which impose strict numerical
investment or ownership tests for determining whether a venture capital
fund exercises supervision or influence over the operation or business
of the operating company? \131\ Does the fact that the assistance need
only be offered render the condition so readily met that the criterion
should be removed from the rule? Should our rule provide guidance on
what constitutes ``control'' under our proposed definition? For
example, instructions to Form ADV provide a presumption of control if a
person has the power to vote 25 percent or more of a corporation's
voting securities, or a person acts as manager of a limited liability
company.\132\ Should the proposed rule rely on similar or different
presumptions?
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    \129\ Section 2(a)(47) of the Investment Company Act states:
     ```Making available significant managerial assistance' by a
business development company means--
    (A) Any arrangement whereby a business development company,
through its directors, officers, employees, or general partners,
offers to provide, and, if accepted, does so provide, significant
guidance and counsel concerning the management, operations, or
business objectives and policies of a portfolio company;
    (B) the exercise by a business development company of a
controlling influence over the management or policies of a portfolio
company by the business development company acting individually or
as part of a group acting together which controls such portfolio
company; or
    (C) with respect to a small business investment company licensed
by the Small Business Administration to operate under the Small
Business Investment Act of 1958, the making of loans to a portfolio
company.
    For purposes of subparagraph (A), the requirement that a
business development company make available significant managerial
assistance shall be deemed to be satisfied with respect to any
particular portfolio company where the business development company
purchases securities of such portfolio company in conjunction with
one or more other persons acting together, and at least one of the
persons in the group makes available significant managerial
assistance to such portfolio company, except that such requirement
will not be deemed to be satisfied if the business development
company, in all cases, makes available significant managerial
assistance solely in the manner described in this sentence.''
    In contrast to section 2(a)(47) of the Investment Company Act,
our proposed definitional approach to managerial assistance does not
specifically define managerial assistance by referring to a fund's
directors, officers, employees, or general partners or address how
managerial assistance is determined for funds that invest as a
group.
    \130\ According to one study, funds focusing on later-stage
companies and middle-market buyout investing tend to invest
alongside other funds, whereas venture capital funds focusing on
early stage companies tend to invest individually in portfolio
companies. See Fenn et al., supra note 55, at 31.
    \131\ See supra note 70 and accompanying text (discussing the
California VC exemption and the VCOC exemption).
    \132\ See Amendments to Form ADV, Investment Advisers Act
Release No. 3060 (July 28, 2010) [75 FR 49234 (Aug. 12, 2010)]
(``Form ADV Release'').
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    Our proposed rule provides that when a fund controls the qualifying
portfolio company, an offer to provide managerial assistance is not
required. As in the case of ``managerial assistance'' as defined in the
BDC provisions, the proposed rule presumes that when a fund acquires
control, it is likely to be exercised. Should the rule specify that in
all cases managerial assistance includes both the offer of assistance
as well as the exercise of control? We request comment on whether
venture capital funds (or their advisers) typically have the personnel
to provide significant managerial assistance to all of their portfolio
companies or only a subset. Would the requirement to offer and
potentially provide managerial assistance to all of a fund's portfolio
companies result in potential demands on a fund or its adviser that
could not be satisfied if all or a significant subset of a fund's
portfolio companies accepted the offer? Alternatively, does the
proposed definition provide a venture capital fund (including those
that invest as a group) with sufficient flexibility to determine the
scope of any managerial assistance or control it may seek to offer (or
provide) to a portfolio company?
2. Limitation on Leverage
    Under proposed rule 203(l)-1, the definition of a venture capital
fund for purposes of the exemption would be limited to a private fund
that does not borrow, issue debt obligations, provide guarantees or
otherwise incur leverage, in excess of 15 percent of the fund's capital
contributions and uncalled committed capital, and any such borrowing,
indebtedness, guarantee or leverage is for a non-renewable term of no
longer than 120 calendar days.\133\ Under the proposed definition, a
fund could borrow and still be a venture capital fund provided it did
not borrow or otherwise use leverage in excess of the specified
threshold.
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    \133\ Proposed rule 203(l)-1(a)(4). Similarly, our proposed rule
would exclude from the definition of ``qualifying portfolio
company'' a company that borrowed in connection with the venture
capital fund's investments in the company. Proposed rule 203(l)-
1(c)(4)(ii). See supra section II.A.1 of this Release.
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    By specifying that loans be non-renewable, we would avoid the
transformation of short-term debt into long-term debt without full
repayment to the lender. Should the rule specify other borrowing or
financing terms or conditions that would nevertheless avoid this type
of transformation? Do venture capital funds use lines of credit
repeatedly but pay the outstanding amounts in full before drawing down
additional credit? Should loans of this nature be included in the
definition? Under our proposed definition, it would be possible for a
venture capital fund to issue commercial paper on a short-term basis to
potential investors because the proposed definition does not specify
which types of instruments a venture capital fund issues. Should the
proposed rule specifically exclude commercial paper from debt issuances
to avoid the potential that a venture capital fund could convert short-
term debt into long-term debt by continuing to roll over its commercial
paper

issuances? \134\ This criterion regarding leverage at the venture
capital fund level is in addition to the conditions relating to a
qualifying portfolio company's debt issuances in connection with the
venture capital fund's investment.\135\ Under this condition, a venture
capital fund seeking to satisfy the definitional criteria could not
avoid the borrowing element at the portfolio company level by incurring
such leverage at the venture capital fund level.
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    \134\ We note that because commercial paper issuers often
refinance the repayment of maturing commercial paper with newly
issued commercial paper, they may face roll-over risk, i.e., the
risk that investors may not be willing to refinance maturing
commercial paper. These risks became particularly apparent for
issuers of asset-backed commercial paper beginning in August 2007.
At that time, structured investment vehicles (``SIVs''), which are
off-balance sheet funding vehicles sponsored by financial
institutions, issued commercial paper to finance the acquisition of
long-term assets, including residential mortgages. As a result of
problems in the residential home mortgage market, short-term
investors began to avoid asset-backed commercial paper tied to
residential mortgages, regardless of whether the securities had
substantial exposure to sub-prime mortgages. Unable to roll over
their commercial paper, SIVs suffered severe liquidity problems and
significant losses. See Money Market Fund Reform, Investment Company
Act Release No. 28807 (June 30, 2009) [74 FR 32688 (July 8, 2009)]
(``Money Market Fund Reform Release'') at nn.37-39 and preceding and
accompanying text; Marcin Dacperczyk and Philipp Schnabl, When Safe
Proved Risky: Commercial Paper During the Financial Crisis of 2007-
2009 (Nov. 2009).
    \135\ See proposed rule 203(l)-1(c)(4)(ii); supra section
II.A.1.c of this Release. Because private equity funds often engage
in leveraged buy-out transactions in which the portfolio company,
rather than the fund, incurs debt, our proposed definition would
exclude leveraged buy-out funds.
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    Congress cited the implementation of trading strategies that use
financial leverage by certain private funds as creating a potential for
systemic risk.\136\ In testimony before Congress, the venture capital
industry identified the lack of financial leverage in venture capital
funds as a basis for exempting advisers to venture capital funds \137\
in contrast to other types of private funds such as hedge funds, which
may engage in trading strategies that may contribute to systemic risk
and affect the public securities markets.\138\ For this reason, our
proposed rule is designed to address concerns that financial leverage
may contribute to systemic risk by excluding funds that incur more than
a limited amount of leverage from the definition of venture capital
fund.\139\
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    \136\ See, e.g., section 115 of the Dodd-Frank Act (enumerating
prudential standards for addressing systemic risks, including risk-
based capital requirements, leverage limits, liquidity requirements,
resolution plan and credit exposure report requirements,
concentration limits, a contingent capital requirement, enhanced
public disclosures, short-term debt limits, and overall risk
management requirements). See also G20 Working Group 1, Enhancing
Sound Regulation and Strengthening Transparency, at iii-iv (March
25, 2009) (``G20 Working Group Report''), at iii (noting
contribution to ``market turmoil'' when ``the financial system
developed new structures and created new instruments, some with
embedded leverage.'' Further, ``[w]hile the build-up of leverage and
the underpricing of credit risk were recognized in advance of the
turmoil, their extent was under-appreciated and there was no
coordinated approach to assess the implications of these systemic
risks * * *''); International Monetary Fund, Lessons of the Global
Crisis for Macroeconomic Policy, February 19, 2009, at 6 (noting how
``[l]everage * * * increases lender exposure by magnifying the
impact of a price adjustment on borrowers' balance sheets and, thus
on banks' losses and capital.''). See generally Department of
Treasury, Financial Regulatory Reform, A New Foundation: Rebuilding
Financial Supervision and Regulation, June 2009, available at http://www.financialstability.gov/docs/regs/FinalReport_web.pdf.
    \137\ See McGuire Testimony, supra note 41, at 7 (``Venture
capital firms do not use long term leverage, rely on short term
funding, or create third party or counterparty risk * * * [F]rom
previous testimony submitted by the buy-out industry, the typical
capital structure of the companies acquired by a buyout fund is
approximately 60% debt and 40% equity. In contrast, borrowing at the
venture capital fund level, if done at all, typically is only used
for short-term capital needs (pending drawdown of capital from its
partners) and does not exceed 90 days. Not only are our partnerships
run without debt but our portfolio companies are usually run without
debt as well.''); Loy Testimony, supra note 40, 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.'').
    \138\ See S. Rep. No. 111-176, supra note 7, at 74-75.
    \139\ In proposing an exemption for advisers to private equity
funds, which would have required the Commission to define the term
private equity fund, the Senate Banking Committee noted the
difficulties in distinguishing some private equity funds from hedge
funds and expected the Commission to exclude from the exemption
private equity funds that raise significant potential systemic risk
concerns. S. Rep. No. 111-176, supra note 7, at 75. See also G20
Working Group Report, supra note 136, at 7 (noting that unregulated
entities such as hedge funds may contribute to systemic risks
through their trading activities).
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    We also understand that venture capital funds generally do not rely
on short-term financing,\140\ which has been identified as another
potential systemic risk factor.\141\ Should we increase or reduce the
15 percent threshold for short-term borrowing? If so, what is the
appropriate threshold (e.g., 20, 10, or 5 percent)? Or should we define
a venture capital fund as a private fund that does not borrow at all or
otherwise incur any financial leverage? Would even the limited ability
to engage in short-term borrowing or other forms of leverage encourage
venture capital funds to incur other investment risks different from
those typically associated with venture capital investing today? To the
extent that venture capital funds use short-term leverage or borrowing,
90 days has been cited as typical.\142\ Would a 120-day period, as
specified in our proposed rule, create other investment risks for
venture capital funds? Our proposed rule refers specifically to
borrowing but also is designed to give venture capital funds the
flexibility to issue debt (which is also a form of borrowing) for
short-term purposes. Should the rule refer specifically to additional
forms of borrowing not already identified? Do any or many venture
capital funds borrow in excess of 120 days? Should the 15 percent limit
not apply when a fund borrows in order to invest in a qualifying
portfolio company and is repaid with capital called from the fund's
investors? Would the 120-day limit alone achieve a similar result?
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    \140\ See Loy Testimony, supra note 40, at 7 (``[V]enture
capital firms do not generally rely on short-term funding. In fact,
quite the opposite is true.''); Schell, supra note 101, at Sec.
1.03[6] (``Venture Capital Funds rarely have the ability to borrow
money, other than short-term loans to cover Partnership Expenses or
to `bridge' Capital Contributions.''); Heesen, supra note 104, at
17.
    \141\ See, e.g., Financial Crisis Inquiry Commission,
Preliminary Staff Report, Shadow Banking and the Financial Crisis
(May 4, 2010).
    \142\ See McGuire Testimony, supra note 41, at 7.
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    Our proposed rule specifies that the 15 percent calculation must be
determined based on the fund's aggregate capital contributions and
uncalled capital commitments. Unlike most registered investment
companies or hedge funds, venture capital funds rely on investors
funding their capital commitments from time to time in order to acquire
portfolio companies.\143\ A capital commitment is a contractual
obligation to acquire an interest in, or provide the total commitment
amount over time to, a fund, when called by the fund. Accordingly,
advisers to venture capital funds manage the fund in anticipation of
all investors fully funding their commitments when due and typically
have the right to penalize investors for failure to do so.\144\ Venture

capital funds are subject to investment restrictions, and calculate
fees payable to an adviser, as a percentage of the total capital
commitments of investors, regardless of whether or not the capital
commitment is ultimately funded by an investor.\145\ Venture capital
fund advisers typically report and market themselves to investors on
the basis of aggregate capital commitment amounts raised for prior or
existing funds.\146\ These factors would lead to the conclusion that,
in contrast to other types of private funds, such as hedge funds, which
trade on a more frequent basis, a venture capital fund would view the
fund's total capital commitments as the primary metric for managing the
fund's assets and for determining compliance with investment
guidelines. Hence, we believe that calculating the leverage threshold
to include uncalled capital commitments is appropriate, given that
capital commitments are already used by venture capital funds
themselves to measure investment guideline compliance.