The WSJ is reporting on an effort by Senator Jack Reed’s efforts to lump venture capital firms in with PE shops and hedge funds. This legislation will require VC funds over $100 million to register with the SEC. Senator Reed’s point is that, to quote from the WSJ piece, “I don’t think we have the regulatory capacity to evaluate everyone’s business model to see if they’re venture capital-heavy or private equity-heavy.”
I do see his point. The problem isn’t venture capital firms, which pretty much not going to be a systematic risk to the US financial system (as I’ve mentioned before) but instead Hedge Funds pretending to be venture capital firms. Hedge funds can hire pretty good lawyers. I’d be shocked if many couldn’t find a way to “look” like a VC on paper… at least in the eyes of an overworked underpaid regulator who only has a few minutes to decide what sort of a beast a fund is, based off of some form submitted by a slick law firm.
I wonder if there is some sort of industry self-regulation that could work here? Would it be possible for the NVCA to judge if a firm is actually a venture fund or not? Not sure how that would work; just throwing it out there.
May 11th, 2010 at 8:02 pm
I have not followed this particular craziness, but aren't there two regulatory concerns: (1) Whether or not the fund holds or trades public stock or public debt and (2) whether or not the fund leverages with debt. Typical VC funds don't do either and they don't invest in companies that employ much leverage (beyond venture debt, which is always way less than the equity invested, or SVB type lines). It seems to me that it would be pretty easy to separate VC funds from Hedge funds.
May 11th, 2010 at 8:18 pm
Dave, I'm very confident hedge funds can hire good enough legal advice to look like VC firms, on paper. So I think it might actually be very hard to police the hedge funds that want to do this.
For Point 1, there are some VCs who do sometimes go into the public markets. For example, I think Spark Capital picked up big slug of CNET a few years ago and generated a nice return. Also, sometimes VCs hold stock in private companies that go public (not that we've had that many VC backed IPOs recently!!). And every now and then the VC will purchase into that public company by buying public stock. It's pretty rare, but I wouldn't want to basically prohibit VCs from doing these sorts of things. Not sure how any regulation would allow VCs to sometimes do this stuff without allowing hedge funds to pretend to be venture capitalists.
Point 2 is probably not quite as clear as one would hope. Some VC funded companies do have debt, either convertible debt or venture debt. Again, I really don't think these represent real dangers to the financial system, but some do use modest amounts of non-dangerous debt. However, they are not levering up the actual FUND, which is what some hedge funds do. Again, I'm not saying it is all that hard to tell a typical VC from a typical hedge fund, but just that some sneaky hedge funds could probably pretend to be VCs i the eyes of the regulators.
May 11th, 2010 at 8:20 pm
Actually, another thought. What about corporate VCs? Will they have to be regulated? What is the parent corporation has debt? Does that make the corporation's venture fund a debt enhanced vehicle?