In a March 12 no-action letter to lawyers at Latham & Watkins, Jeb Byrne, the chief of small business policy at the SEC’s division of corporation finance, offered a small piece of guidance on how fund managers must evaluate their LPs that may have an outsized impact on venture capital GPs’ ability to raise their funds.
Byrne said in his e-mail that commission staffers “agree that a high minimum investment amount is a relevant factor in verifying accredited investor status,” and that as long as a fund manager does not previously know that a potential LP does not meet the threshold to be considered an accredited investor, then that fund manager “could reasonably conclude that it has taken reasonable steps to verify that purchasers of securities sold in an offering under Rule 506(c) of Regulation D are accredited investors.”
Jen Conwell, a director at regulatory consulting firm Iron Road Partners and 24-year veteran of the SEC, says this new guidance opens the door for more firms to utilize the benefits of registering under rule 506(c).
“506(c) as written was cumbersome and rarely used; this no-action letter reduces the burden of verification, paving the way for wider adoption of general solicitation,” Conwell tells Venture Capital Journal in an e-mail.
‘General solicitations’
Under rule 506(c) of the JOBS Act, fund managers are allowed to make “general solicitations” – or advertise their funds to the general public – as long as they are only marketed to accredited investors. The issue firms faced previously was that the SEC’s guidelines around proving someone is an accredited investor were vague, leading the firms to launch lengthy background checks and other processes to ensure they were not violating general solicitation rules.
Because of this, many funds filed under rule 506(b), which limits their ability to advertise the fund and in turn makes it more challenging to find investors, especially for emerging managers who cannot rely on large, well-known institutional LPs.
Regina Green, managing director of investments at fund accelerator Catalyze, agrees this new guidance will help emerging managers find different sources of capital.
“I expect this change will provide firms with additional opportunities to communicate strategically about the launch of a new fund and to reach a wider population of investors,” she tells VCJ. “Emerging managers are particularly well suited to benefit from this change given their ability to bring new investors, and in turn new capital, into the private markets ecosystem.”
However, not everyone in the VC ecosystem thinks this guidance will have a big impact for emerging managers.
“Emerging managers are likely to have LPs that don’t meet the $200,000 investment minimum,” explains Nik Talreja, CEO of SPV and fund automation platform Sydecar. “This means that if they do raise under 506(c), they will still need to verify the accredited status for any smaller investors – so some friction still remains.”
Evan O’Donnell, a general partner at early-stage investment firm Timespan, agrees with Talreja, saying in an email, “My general take is that I don’t think this meaningfully shifts things much for emerging managers. It certainly simplifies things a bit, but there are still a number of considerations that aren’t addressed – limitations in jurisdictions outside of the US or funds that want to take on smaller checks below $200,000 from more strategic LPs, for example.”
As to how quickly the new SEC guidance will permeate the market, most VCs seem to think it will take awhile. Regulatory issues are often complex and, given the repercussions if rules are broken, many GPs will likely work with legal experts over the coming months to examine the SEC’s rules and determine the best course of action.
“It’s hard to say if the rule change will result in significantly more funds registering under 506(c) in the near term, but the rule change should make it a more viable path in the medium run,” Green tells VCJ. “I think it will take some time for the market to appreciate the circumstances under which a manager would choose this path and neutralize the historical stigma around public solicitation, which could make some managers reluctant to go this route.”
Talreja adds a positive note to his response to VCJ’s request for comment, which was mirrored by similar quotes from most of the sources we reached out to for this letter.
“It’s certainly exciting to see regulatory easing at the SEC that has the intent to further private market activity,” he says. “We are encouraged by this news and hope it signals further SEC guidance and rule-making that makes it easier for individuals to qualify as ‘accredited investors’ and participate in primary and secondary investment opportunities.”
In a March 12 no-action letter to lawyers at Latham & Watkins, Jeb Byrne, the chief of small business policy at the SEC’s division of corporation finance, offered a small piece of guidance on how fund managers must evaluate their LPs that may have an outsized impact on venture capital GPs’ ability to raise their funds.
Byrne said in his e-mail that commission staffers “agree that a high minimum investment amount is a relevant factor in verifying accredited investor status,” and that as long as a fund manager does not previously know that a potential LP does not meet the threshold to be considered an accredited investor, then that fund manager “could reasonably conclude that it has taken reasonable steps to verify that purchasers of securities sold in an offering under Rule 506(c) of Regulation D are accredited investors.”
Jen Conwell, a director at regulatory consulting firm Iron Road Partners and 24-year veteran of the SEC, says this new guidance opens the door for more firms to utilize the benefits of registering under rule 506(c).
“506(c) as written was cumbersome and rarely used; this no-action letter reduces the burden of verification, paving the way for wider adoption of general solicitation,” Conwell tells Venture Capital Journal in an e-mail.
‘General solicitations’
Under rule 506(c) of the JOBS Act, fund managers are allowed to make “general solicitations” – or advertise their funds to the general public – as long as they are only marketed to accredited investors. The issue firms faced previously was that the SEC’s guidelines around proving someone is an accredited investor were vague, leading the firms to launch lengthy background checks and other processes to ensure they were not violating general solicitation rules.
Because of this, many funds filed under rule 506(b), which limits their ability to advertise the fund and in turn makes it more challenging to find investors, especially for emerging managers who cannot rely on large, well-known institutional LPs.
Regina Green, managing director of investments at fund accelerator Catalyze, agrees this new guidance will help emerging managers find different sources of capital.
“I expect this change will provide firms with additional opportunities to communicate strategically about the launch of a new fund and to reach a wider population of investors,” she tells VCJ. “Emerging managers are particularly well suited to benefit from this change given their ability to bring new investors, and in turn new capital, into the private markets ecosystem.”
However, not everyone in the VC ecosystem thinks this guidance will have a big impact for emerging managers.
“Emerging managers are likely to have LPs that don’t meet the $200,000 investment minimum,” explains Nik Talreja, CEO of SPV and fund automation platform Sydecar. “This means that if they do raise under 506(c), they will still need to verify the accredited status for any smaller investors – so some friction still remains.”
Evan O’Donnell, a general partner at early-stage investment firm Timespan, agrees with Talreja, saying in an email, “My general take is that I don’t think this meaningfully shifts things much for emerging managers. It certainly simplifies things a bit, but there are still a number of considerations that aren’t addressed – limitations in jurisdictions outside of the US or funds that want to take on smaller checks below $200,000 from more strategic LPs, for example.”
As to how quickly the new SEC guidance will permeate the market, most VCs seem to think it will take awhile. Regulatory issues are often complex and, given the repercussions if rules are broken, many GPs will likely work with legal experts over the coming months to examine the SEC’s rules and determine the best course of action.
“It’s hard to say if the rule change will result in significantly more funds registering under 506(c) in the near term, but the rule change should make it a more viable path in the medium run,” Green tells VCJ. “I think it will take some time for the market to appreciate the circumstances under which a manager would choose this path and neutralize the historical stigma around public solicitation, which could make some managers reluctant to go this route.”
Talreja adds a positive note to his response to VCJ’s request for comment, which was mirrored by similar quotes from most of the sources we reached out to for this letter.
“It’s certainly exciting to see regulatory easing at the SEC that has the intent to further private market activity,” he says. “We are encouraged by this news and hope it signals further SEC guidance and rule-making that makes it easier for individuals to qualify as ‘accredited investors’ and participate in primary and secondary investment opportunities.”
