The SEC fulfilled their obligation under the Frank-Dodd financial reform bill and defined what venture capital is.
Represents itself to investors as being a venture capital fund.
Only invests in equity securities of private operating companies to provide primarily operating or business expansion capital (not to buy out other investors), U.S. Treasury securities with a remaining maturity of 60 days or less, or cash.
Is not leveraged and its portfolio companies may not borrow in connection with the fund’s investment.
Offers to provide a significant degree of managerial assistance, or controls its portfolio companies.
Does not offer redemption rights to its investors.
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Here’s what would, according to this definition, be illegal for a venture capital fund to undertake:
- Private investment in public entity (PIPE) financing. This is where a VC fund invests in a publicly traded company and the proceeds of that investment go not to other investors but to the company in exchange for preferential shareholder rights. This has been a lucrative area for VC funds to invest in and has also been critically important for companies to tap when other finance options (e.g. debt) prove to be onerous.
- Investor/founder buyouts. It’s not uncommon for a VC to invest in a company and have a portion of the invested capital go to buying out founders and other investors. It’s a way for founders to get some liquidity and for companies to dispose of investors who have external pressures related to liquidity.
- Bridge financing. According to this definition a venture capital firm may only invest in equity securities, which would suggest that a VC firm would be prohibited from offering debt financing… at least under a strict reading.
This is yet another example of legislative overreach, venture capital is a very small percentage of private equity overall and in no way contributed to the last financial crisis so why is this regulatory definition necessary? It’s not and it won’t be helpful for investors who have a demonstrable track record of business and job creation.
(Cross-posted @ Jeff Nolan - Venture Chronicles)