This week, as part of its drive to encourage and facilitate the growth of venture capital in Europe, the European Commission published a proposal for a legislative framework for venture capital funds – click here for the SJ Berwin PDF.
If approved, this new regulation will allow managers of "European Venture Capital Funds" (as they will be officially, and exclusively, designated) to raise capital freely throughout the European Economic Area from certain types of investors. The new rules would be optional, so that venture managers would only "opt-in" to the new regulatory regime if they wanted to take advantage of the marketing passport, and this regime would sit alongside existing national rules, rather than replace them. It would mean, however, that the key benefit which is made available to funds covered by the Alternative Investment Fund Managers Directive would also be available to qualifying venture fund managers – without the need for them to be subject to the very demanding regulatory regime which that Directive requires.
The new regulation will only be available to managers whose "venture capital fund" assets under management do not exceed €500 million (£430 million). It is designed for funds that invest at least 70% of their committed capital in unlisted SMEs, where those SMEs issue equity or "quasi equity" instruments directly to the venture capital investor and which do not employ leverage at the fund level. An SME for this purpose (in common with other EU legislation) is an undertaking which employs fewer than 250 persons, and either has an annual turnover not exceeding €50 million (£43 million) or an annual balance sheet not exceeding €43 million (£37 million), and which is not itself a fund. Helpfully, the regulation makes it clear that the portfolio company only needs to qualify as an SME at the time of investment by the fund.
Some may be disappointed that the Commission has decided against extending the scope of the regulation to all private equity fund managers below the AIFM Directive threshold. However, the Commission has not imposed any further limitations on the use of the remaining 30% of committed capital contributions (from which any operational expenses would have to come), and has not opted for an overly prescriptive definition of the venture capital fund’s activities and strategies, as it had considered in its earlier deliberations. Its approach is, therefore, likely to be welcomed by the industry – although some larger venture fund managers who are above the AIFMD threshold will be disappointed that they cannot opt for this framework instead of the AIFMD.
Also welcome will be the Commission’s decision to allow certain high net worth individuals, family offices and business angels to be included in the range of investors who can be marketed to under the marketing passport. The current formulation of this test may need more work – the Commission’s proposal requires a minimum investment of €100,000 (£85,000), and asks the manager to assess (among other things) the "expertise, experience and knowledge" of the investor – but the principle is a positive change in approach. There is also a commitment to review the market four years following implementation of this new framework to determine whether it is appropriate to broaden the scope of potential investors in venture capital funds.
There is, of course, a regulatory price for the passport, but it does seem to be relatively light – at least as currently proposed, and before some of the detailed implementation rules have been clarified. There will be various reporting and disclosure requirements, and general principles governing conduct of business, relationship with investors and other organisational requirements. There is also a requirement to have "sufficient own funds and use adequate and appropriate human and technical resources as are necessary for the proper management of qualifying venture capital funds" – a phrase which is clearly capable of differing interpretations.
Overall, these are positive proposals which take on board many of the concerns expressed by the venture capital industry in earlier discussions with the Commission. There are some remaining disappointments (for example, no suggestion that funds of funds can benefit, and no third country regime), and some of those (as well as the detail of the restrictions and regulatory requirements) will no doubt be the subject of further discussion with national governments and the European Parliament, to whom these proposals will now go. Whether they emerge from those discussions in similar form to those published on Wednesday is by no means certain, and this may prove to be the Commission’s opening shot in a lengthy process.