The Rules a Fund Operates Under

Not legal advice. Securities law is specific to each jurisdiction and each set of facts. This module describes the landscape so you can have a better conversation with fund counsel.

Two separate questions

Securities law asks two different things of a venture fund:

1. Raising the fund. Fund interests are securities. Selling them requires either a prospectus (a public offering, which venture funds don't do) or an exemption.
2. Managing the fund. The people advising and running the fund may themselves need to be registered, or to qualify for an exemption.

Canada

Securities regulation in Canada is provincial, harmonised through national instruments adopted by the Canadian Securities Administrators (CSA). Two matter most.

Raising: NI 45-106

Venture funds raise under the prospectus exemptions in National Instrument 45-106, most commonly the accredited investor exemption. After a distribution, the fund files a report of exempt distribution (Form 45-106F1) with the relevant regulators within 10 days. A fund with investors in several provinces files in each of them.

Managing: NI 31-103

National Instrument 31-103 sets out the registration categories. Three come up for fund managers:

• Investment fund manager (IFM) — directs the business of an investment fund.
• Adviser (portfolio manager) — advises on or manages investments in securities.
• Dealer, often an exempt market dealer (EMD) — in the business of trading securities, which can include selling fund interests.

The pivotal question for a VC manager is whether its fund is an "investment fund" at all. Regulators generally say it isn't when the manager is actively involved in managing the companies it invests in. The Alberta Securities Commission puts it plainly: in that case the VC "would not need to register as an investment fund manager." Venture's hands-on model, with board seats and operating involvement, is what supports that position. Which is also why it has to be true in practice, not just in the pitch deck.

Dealer registration is a separate question. Whether raising the fund puts the manager "in the business" of trading depends on the facts; many managers sell through a registered EMD or rely on an exemption. This is exactly the analysis to have counsel do before the first close.

A Canadian fund with US investors, or a US fund with Canadian ones, has to satisfy both regimes.

United States

Raising: Regulation D and the Investment Company Act

US venture funds typically sell interests under Regulation D: usually Rule 506(b), or Rule 506(c) if they want to advertise, which requires taking reasonable steps to verify that investors are accredited. They file a Form D with the SEC within 15 days of the first sale.

To avoid being regulated as an investment company, they rely on an exclusion in the Investment Company Act. Section 3(c)(1) limits the number of beneficial owners, generally to 100. Section 3(c)(7) requires every investor to be a "qualified purchaser."

Managing: exempt reporting advisers

Since the Dodd-Frank Act, most venture managers operate as exempt reporting advisers (ERAs) rather than registered investment advisers, under one of two exemptions:

• The venture capital fund adviser exemption, for managers that advise only funds meeting the SEC's definition of a venture capital fund.
• The private fund adviser exemption, for managers with less than $150M of private fund assets under management in the US.

Exempt doesn't mean unregulated. ERAs file parts of Form ADV within 60 days of relying on the exemption and update it annually within 90 days of fiscal year end. They remain subject to the Advisers Act's anti-fraud rules and to SEC examination, and state filings may apply too.

The venture capital fund definition has teeth

To use the VC adviser exemption, every fund the manager advises has to meet the definition. Among its conditions:

• The 20% basket. No more than 20% of the fund's capital commitments can go into "non-qualifying" investments. Qualifying investments are, broadly, equity bought directly from private operating companies. Secondary purchases, fund-of-funds positions and many digital assets use up the basket.
• Limited leverage. Borrowing is restricted to short-term amounts, capped as a share of the fund's capital.
• No redemption rights for investors, except in extraordinary circumstances.
• Holding out. The fund has to present itself to investors as pursuing a venture capital strategy.

The 20% basket is where investing and compliance collide. An associate excited about buying secondary shares in a hot company is proposing to spend a finite regulatory budget. Ops should track basket usage the way finance tracks reserves.

The compliance calendar

Whatever the jurisdiction, fund compliance settles into a calendar:

What this means for you

Fund ops often owns this calendar outright, usually with outsourced compliance support and outside counsel. On the investing side, know the constraints before you pitch something unusual. A secondary purchase, a crypto position or an investment in another fund may raise regulatory questions long before it raises investment ones.