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Friday Letter: Flex by SEC gives VCs growing pains

The SEC has proposed new rules around Form PF, which would require private funds that are registered investment advisers to notify the SEC within one business day of certain events, such as clawbacks, removal of a fund’s GP or adviser-led secondaries transactions.

Growing up sucks.

That must be how some venture capital firms feel this week, namely those that went through the complicated process of becoming registered investment advisers. They got a double dose of bad news from the SEC.

First, the regulator proposed new rules around Form PF, which would require advisers to private equity funds (including VC funds that are RIA) to notify the SEC within one business day of certain events, such as clawbacks, removal of a fund’s GP or adviser-led secondaries transactions. (My colleagues at Regulatory Compliance Watch have the full scoop.)

Just a day after proposing the new rules, the SEC issued a scathing risk alert based on its observations from examinations of private funds. Among the concerns it highlighted are a “failure to act consistently with disclosures” and “use of misleading disclosures regarding performance and marketing.”

For VCs that only recently became registered investment advisers, that news has to raise alarm bells.

By my count, more than a dozen venture firms are RIAs. Some have been registered for a decade or more, including Bain Capital Ventures (registered in 2008), Iconiq Capital (2011) and Sapphire Ventures (2012). But many have joined the ranks in only the past few years. Sequoia Capital officially registered in January, Thrive Capital became an RIA in September 2021, and Andreessen Horowitz and General Catalyst Partners both registered in April 2019.

Given that the US is home to nearly 2,000 venture firms (per the National Venture Capital Association), VCs that are RIAs are still a rare breed. “Of the clients we represent, it’s still a very small number that have decided to jump in,” said Sean Caplice, a fund formation attorney with Gunderson Dettmer whose lengthy list of VC clients includes Andreessen Horowitz, Benchmark, Felicis Ventures and True Ventures.

“I wouldn’t say firms should be worried about [the SEC news],” Caplice said. “It comes with the territory of being an RIA, which underscores why many venture firms elect not to go down the path of the registration process.”

As appetites grow for non-traditional investments – such as crypto, secondaries and debt – I expect we will see more VCs start to register with the SEC. If non-traditional assets exceed more than 20 percent of your AUM, you are officially in RIA territory.

This doesn’t mean that you need to call an emergency partners’ meeting. If you do traditional VC investing and have no plans to change your strategy, you will probably remain exempt from registration for a while. However, it would be foolhardy to expect to avoid SEC scrutiny. Chairman Gary Gensler has made clear he wants to rein in private funds, including those in venture. One of his top priorities is to reform Regulation D of The JOBS Act, which exempts VC funds from having to register with the SEC.

Now is a good time to weigh the pros and cons of becoming a registered investment advisor. For the moment, you have time to be thoughtful about it. Who knows if that will be the case in a year or two?

Let me know what you are thinking about this topic.

Email me at lawrence.a@peimedia.com.