SEC Advisory Committee Considers Challenges to Small Business Capital Raising

The SEC Small Business Capital Formation Advisory Committee began deliberations on the (i) limits of arm's length "venture capital fundraising," (ii) registration exemptions based on the current definition of investment company under the Investment Company Act and (iii) challenges that emerging managers face in raising capital and finding investment opportunities.

SEC Chair Gary Gensler highlighted that the $30 trillion private fund sector has surpassed the size of the US banking sector. He emphasized the role that venture capital funds play in alternative capital raising, noting that VC fund advisers also give advice to startups and entrepreneurs. Mr. Gensler also acknowledged the challenges facing new fund managers, saying that everyone deserves access to US capital markets, regardless of background, color, gender, or geography. 

SEC Commissioner Mark T. Uyeda questioned the current efficacy of exemptions under Section 3(c)(1) under the Investment Company Act, which allows private funds to raise capital without registration, provided the fund has 100 or fewer beneficial owners, among other provisions. Mr. Uyeda asked whether the 100-investor limit remains "appropriate."  He said that it may now be "easier for smaller funds to raise capital," especially with modern tools like general solicitation via the internet. Mr. Uyeda also expressed concern over the compliance burdens facing small advisers, calling them a "significant barrier to entry" and a "hurdle for emerging fund managers."

Commissioner Hester M. Peirce emphasized the need to lower barriers to entry for fund managers, noting that to be effective, capital markets must be able to "get money into the hands of good managers, regardless of whether they have rich friends and family." She pointed to the use of Rule 506(c), which allows issuers to publicly advertise a private offering as long as all purchasers are accredited and the issuer takes steps to verify their status. Despite this, she said, Rule 506(c) has seen limited use, with only 8.4 percent of VC funds utilizing it since 2013. She urged the Committee to consider (i) how the SEC could reduce the "cost and legal risk" associated with the verification requirement for accredited investors under Rule 506(c); (ii) whether investors should be allowed to self-certify their accredited status to lower these costs and risks; (iii) whether reducing verification costs would address the "negative signal" some funds might send when using 506(c) (suggesting they lack the necessary personal network to fundraise traditionally); and (iv) whether increasing the investor cap or raising capital limits for certain VC funds would enhance fundraising opportunities for emerging managers.