A possible new regime for European VC

With the EU’s post-financial crisis wave of legislative activity in full swing, the European Commission recently proposed to deal specifically with venture capital in its consultation paper entitled “A New Regime for European Venture Capital”, published this June. Notably, the paper offers the prospect of a general exemption for EU-based venture capital fund managers from the AIFMD regime, which would otherwise apply to those exceeding the €500 million AUM threshold.

The paper discusses three distinguishing factors of a venture capital fund: the character of investment, the target of investment and the exclusionary criterion. According to the paper, venture capital has a long-term and active character, adding not only investment but providing guidance and expertise. Secondly, to qualify as a venture capital fund, the investment will have to target a small-to-medium sized enterprise (SME) within its first three stages – the seed stage (capital invested into research and development of an initial concept), start-up stage (capital invested in the early stages of operation before generating profit) and expansion stage (capital invested in increasing capacity or sales of a product already being sold).  Thirdly, the exclusionary criterion means that certain investments are regarded as being incompatible with venture capital.  Here, the Commission refers to the SEC’s proposed definition, which expressly excludes, among others, investments into a fund and non-pure equity investments (i.e. investments where the target issues debt obligations to the investor).  

Once these criteria are met, the Commission proposes a registration and passporting mechanism, under which the fund manager would apply to their national regulator – or, alternatively, directly to the European Securities and Markets Association – for a passport. Unlike the AIFMD passport, the venture capital passport would be issued for the manager, rather than individual funds, and therefore every venture capital fund sponsored by the same manager could be made available to professional investors throughout the EU. Where offered under a passport, venture capital investments would only be available to professional investors (as that term is defined in the Market in Financial Instruments Directive).

Restricting investment to professional investors paves the way for a ‘light-touch’ regulatory regime – although enforcement and sanctions are not set out in detail.  In a similar vein, the venture capital firm will be left to choose which legal structure they wish to adopt, as long as it is one “traditionally used in the Member States” – which potentially raises interesting questions in regard to offshore structures. 

The consultation having concluded in August, the Commission expects to bring out detailed legislative proposals by the end of this year. It is hoped that once the gaps are filled in, the proposals will garner industry support and the outcome will be a Community-wide regime providing venture capital funds with an easy, flexible and uniform regulatory environment – and one that is considerably less of a burden than AIFMD.