On Capitol Hill, the differences between “venture capital” and “buyouts” are many, as lobbyists for both groups are quick to point out.
A proposal from the Obama administration to make any private investment firm with more than $30 million register with the Securities and Exchange Commission is being met with howls of protest from venture capitalists and grudging acceptance from the largest buyout firms.
The divergent reactions to the regulatory proposal are not surprising – venture capital firms tend to be small, and forced registration would saddle most of them new burdens in time, cost and human capital requirements. By contrast the private equity firms behind the Private Equity Council (PEC) are the largest buyout firms in the world, some of which are already Registered Investment Advisors, and all of which have the budget flexibility to hire a chief compliance officer.
In testimony before the Congress on 15 July, Trevor Loy, a partner from Flywheel Ventures of Santa Fe, New Mexico, and a member of the board of directors of the National Venture Capital Association (NVCA), pleaded that “venture capital does not belong in this mix” of regulatory proposals.
“By requiring the venture industry to comply with the requirements of the Advisers Act, Congress would be unnecessarily weighing down an asset class that should be focused on building companies and creating jobs, rather than re-directing our resources and time toward administrative functions that our investors did not request and that do not help the entrepreneurs that we fund to create valuable businesses and the jobs that follow.”
A representative of the PEC said as much in his own testimony that day before the Senate Subcommittee on Securities, Insurance and Investment. Mark Tresnowski, managing director and general counsel of Chicago-based Madison Dearborn Partners, warned that SEC registration would impose “considerable administrative and financial burdens associated with record keeping and audits as registered investment advisors” especially for smaller firms. He said any new rules should be created such that “the burdens are tailored to the nature and size of the individual firm and the actual nature and degree of systemic risk it may pose”.
However, the members of the PEC support SEC registration in general. “[W]e are mindful that excluding any asset class from the new regulatory regime could contribute in some way to diminished confidence in the effectiveness of the new regulatory regime and therefore we support the casting of a wide net”.
In addition to size and resources, another potential reason behind the differing stances of the PEC and the NVCA has to do with image. Having spent some 30 years crafting benign attitudes toward venture capital among lawmakers, the NVCA has no need to appear extra cooperative. Buyout firms, on the other hand, are battling the perception among many members of the public and their elected officials that “private equity” inherently leads to over-leverage and job losses. A public acceptance of registration may be part of the PEC’s strategy of giving in to one regulatory incursion so as to better fight a more threatening piece of legislation down the road.
If the NVCA is successful at pulling “venture capital firms” out of the regulatory “mix”, it will be through a very complex feat of interpretation. What is a venture capital firm, and how is it distinct from other private investment firms? Distinctions of this nature have previously confronted the SEC, which several years ago sought to separate “hedge funds” from other investment firms by focusing on a two-year capital lock-up. Before this rule was overturned in court, many hedge funds sought to skirt registration by simply imposing long-term capital lock-ups on investors.
Perhaps most useful approach to regulatory distinction would be through a higher asset “threshold” above which firms would need to register. The Obama administration has proposed $30 million as the right threshold. This would ensnare most private equity and venture capital firms. Even a $100 million requirement would force registration upon many firms that industry insiders agree are “small”, including even venture capital firms.
Beyond a significantly higher asset threshold, the SEC will have a hard time defining venture capital as an asset class distinct from other forms of private investment. If they do, expect to see many, many small buyout firms reverse-engineering themselves to fit into whatever description is put forth as being able to avoid registration.