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Navigating Investment Compliance: Crucial Insights for Your Portfolio

Thursday, September 28, 2023
Written by Venture360 - Finance Team
All Things SPV
Navigating Investment Compliance: Crucial Insights for Your Portfolio

Maintaining investment compliance is an absolute imperative. As regulatory requirements continually evolve, both Investment Fund Organizers and investors must remain vigilant to ensure alignment with the rules set forth by the Securities and Exchange Commission (SEC). To shed light on some of the most pressing compliance inquiries, we've consulted our experts at Venture360, who have addressed five common compliance questions encountered in recent times.

1. Utilizing Rule 506(b) for Capital Raise:

If you're utilizing Rule 506(b) to secure capital for your Special Purpose Vehicle (SPV), you may be aware that this rule allows up to 35 non-accredited investors to participate. However, it's essential to exercise caution when considering non-accredited investors. The complexities arise when your SPV intends to make investments. Portfolio companies often mandate that all investors be accredited, jeopardizing the SPV's investment opportunities.

To qualify as an accredited investor under Rule 506(b), an SPV must meet one of two criteria:

  • Possess total assets exceeding $5,000,000
  • Ensure that all equity owners are accredited investors

The inclusion of just one non-accredited investor can compromise the SPV's accredited investor status, thus hindering its investment capabilities.

2. Limit of Investors in an SPV:

The allowable number of investors in your SPV depends on compliance with the Investment Company Act. The two primary exemptions for SPVs and Funds are as follows:

Section 3(c)(1): An SPV must not exceed 100 beneficial owners under the general rule, or it must have no more than 250 beneficial owners if the SPV or Fund's capital commitment is less than $10 million, and it qualifies as a venture capital fund. Section 3(c)(7): This exemption doesn't impose an investor limit; however, it restricts the SPV to a maximum of 1,999 beneficial owners under the Securities and Exchange Act of 1934. Notably, all investors must be "qualified purchasers."

3. Multiple SPVs to Bypass Section 3(c)(1) Investor Limit:

Attempting to establish multiple entities to circumvent the investor limit under Section 3(c)(1) is not advisable. The SEC has implemented measures to prevent such actions, employing two doctrines: "look-through" and "integration."

Look-through: This applies when one 3(c)(1) fund invests in another 3(c)(1) fund. If the SPV invests 40% or more of its assets into another fund or if the SPV's ownership of the fund accounts for 10% or more of the voting securities, all investors in the SPV contribute to the number of investors in the receiving fund.

Integration: Integration becomes a concern when two SPVs, established by the same group, intend to invest in the same asset. This rule is broadly interpreted based on the facts and circumstances. If reasonable investors perceive the investments as identical, the SPVs are integrated for the purpose of determining the number of investors.

4. Setting Up an SPV or Feeder Fund for Institutional Investment:

Establishing an SPV or feeder fund for investment in an institutional fund is possible, but certain considerations must be taken into account. Most institutional funds rely on Section 3(c)(7), requiring all investors to be qualified purchasers. To qualify as a qualified purchaser, the SPV must either have $25 million in capital commitments or ensure that all beneficial owners within the SPV meet the qualified purchaser criteria.

5. Investment Adviser Registration:

For most SPV and fund managers, registering as an exempt reporting adviser (ERA) or its equivalent at the state level is necessary. Each state may have distinct requirements, but they often align with federal regulations. Two common exemptions found in the Investment Advisers Act pertain to SPV and fund advisers:

Venture capital fund adviser exemption, which applies to advisers solely serving one or more venture capital funds. Private fund adviser exemption, which is relevant to advisers overseeing private funds, such as 3(c)(1) and 3(c)(7) funds, and maintaining assets under management in the US below $150 million.

Navigating investment compliance requires diligence and expertise. It's crucial to consult professionals well-versed in the regulatory landscape, ensuring your investments remain in compliance with ever-evolving rules and regulations. Venture360 can assist you, speak to an expert here.