USA Law and Practice Contributed by: D. Scott Bennett, Nicholas A. Dorsey, Virginia M. Anderson and Ellen H. Park, Cravath, Swaine & Moore LLP
day-to-day governance of the fund and limited remedies against sponsors. As such, the core investor protections are structural in nature. By way of example, investors rely heavily on eco - nomic alignment from capital commitments of the sponsor and exclusivity/deal flow cov - enants. Management fees may step down over time to guard against perverse incentives from the non-deployment of capital, and the carried interest and distribution structure further pro - tects against the sponsor taking profits before investors have achieved some minimum level of return. Some operating agreements also include specific investment-level restrictions, such as concentration limits and outright prohibitions. Actual investor remedies vary from fund to fund, but often include the concept of a suspension period wherein new investments may not be made following certain events such as the death, disability or termination of one or more speci - fied key persons, “cause” , or a change in con - trol of the sponsor. Suspension may lead to the early termination of the fund’s investment period. Some funds have GP removal rights for serious misconduct and others include the right to ter - minate and wind up the fund entirely. 2.3 Fund Regulation Regulation of venture capital funds in the USA generally follows the regulation of the broader private funds industry, with some additional exemptions available to venture capital strate -
pany thereunder. Both exemptions require that the fund interests not be publicly offered. Section 3(c)(1) funds must be beneficially owned by no more than 100 persons (or 250 persons if “venture capital fund” with no more than USD10 million in aggregate capital contributions and uncalled committed capital), without any inde - pendent sophistication requirement. The issue of counting beneficial owners for Section 3(c) (1) purposes is not straightforward, as it may involve looking through certain entities and is subject to “integration” with other similar pools of capital under certain circumstances. Section 3(c)(7) funds have no limitation on the number of beneficial owners. However, all inves - tors must be “qualified purchasers” under the 1940 Act, which includes a range of categories of persons deemed financially sophisticated based on the value of “investments” owned. Regulation of Investment Advisers Venture capital fund sponsors are also subject to regulation under the US Investment Advisers Act of 1940 (the “Advisers Act” ), typically as an “exempt reporting adviser” under Section 203(l) (the “venture capital funds exemption” ) or Sec - tion 203(m) (the “private fund adviser exemp- tion” ). Under the venture capital funds exemption, investment advisers that advise solely one or more venture capital funds are exempt from registration as an investment adviser. The defi - nition of “venture capital fund” under the Advis- ers Act is a private fund that demonstrates that it pursues a venture capital strategy, is subject to certain strict limitations on the fund’s invest - ment holdings (including leverage), and generally prohibits redemptions.
gies, as described here. Investment Company Act
Venture capital funds typically rely on exemp - tions from being considered an investment com - pany under Section 3(c)(1) and/or Section 3(c)(7) of the US Investment Company Act (the “1940 Act” ) to avoid registration as an investment com -
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