On 12 March 2013 the European Parliament officially agreed to the compromise text of the Cyprian Council Presidency on a Regulation on European Venture Capital Funds ("EuVECA-R"). By all accounts will the Council formally adopt the text soon and it can be assumed that it will become law in the form of the present text. The acceptance of the compromise puts an end to a more than a year-long, intense discussion of the regulatory proposal made by the European Commission on 7 December 2011 (the "Commission Proposal", see our client information of the same day) just in time before the end of the transposition period for the Regulation 2011/61/EU on the Managers of Alternative Investment Funds ("AIFM-D") on 22 July 2013.
The essential parts of the EuVECA-R from the Commission Proposal have been maintained:
- Small alternative investment fund managers, that manage less than Euro 500 Million and are only subject to regulation pursuant to the AIFM-D may choose to subject themselves to the EuVECA-R.
- The managers have to register and are then subject to certain operating requirements, minimum capital and resource requirements, valuation provisions in relation to the qualifying funds, transparency requirements towards investors and supervisory authorities.
- Qualifying funds of registered managers may be marketed freely throughout the European Union to the admissible investor groups ("EU Marketing Passport") and may be marketed under the designation "EuVECA".
- A fund qualifies if
- it is intended to invest at least 70% of the part of the capital commitments that may be applied towards investments in qualifying investments and
- at no point in time invests more than 30% of the investable capital commitments in non-qualifying investments.
- Qualifying investments are
- equity and quasi-equity investment in certain SME,
- other equity and quasi-equity investment acquired by exchange of shares
- loans to existing qualifying portfolio companies (in a restricted amount)
- units or shares in directly investing qualifying funds.
- Admissible investors are professional investors in accordance with MiFID and high net-worth individuals. Investments by the team of the manager are permissible.
- Pursuant to the government draft of the transposition legislation for the AIFM-D (KAGB-E) such managers are not subject to any further regulation for their fund management activity. However, it is not absolutely certain that this applies as well to Managers that only manage funds the subscription period of which has already expired.
I. SCOPE OF APPLICATION
The EuVECA-R is applicable to managers of alternative investment funds ("AIFM" or "Manager") within the meaning of the AIFM-D whose assets under management in total do not exceed the threshold of Euro 500 million or whose assets under management subsequently after registration in accordance with the EuVECA-R exceed the threshold of Euro 500 million, Art. 2 para. (1) and (2) EuVECA-R.
With respect to the definition of the threshold the EuVECA-R refers to the provisions in Art. 3 para. (2) lit. b) AIFM-D, i.e. the provision on the managers of exclusively unleveraged alternative investment funds ("AIF"). It is not completely clear whether it is referred to the threshold only or also to the prohibition of managing leveraged AIFs. However, the reference from the provision on AIFM that subsequently after registration exceed the threshold, can be read that the legislator assumed that mangers (also) managing leveraged AIFs shall not fall within the scope of the EuVECA-R.
The management of other, i.e. unleveraged AIF and AIF not meeting the conditions under the EuVECA-R should be allowed.
Furthermore, the EuVECA-R expressly allows the AIFM in addition to manage undertakings for collective investment in transferable securities (UCITS), Art. 2 para. (3) EuVECA-R.
II. QUALIFYING FUNDS – "EuVECA"
To qualify as European venture capital fund, the fund has to meet the conditions of Art. 3 lit. (b) EuVECA-R, namely:
- It must be an AIF within the meaning of Art. 4 para. (1) lit. (a) AIFM-D, i.e. it must be a collective investment undertaking that is no UCITS and collects capital from a number of investors with a view to investing it in accordance with a defined investment policy for the benefit of those investors.
- It must be intended to invest at least 70% of that part of the committed capital that may be employed towards investments in assets that are qualifying investments within a time frame laid down in the fund documentation.
- At no time more than 30% of the investable committed capital may be used for the acquisition of assets other than qualifying investments.
Qualifying venture capital funds that are managed by Manager registered under the EuVECA-R may in future be marketed under the designation "EuVECA", Art. 4 EuVECA-R.
The catalogue of qualifying investments under Art. 3 lit (e) EuVECA-R has been substantively extended. While pursuant to the Commission Proposal the term only included newly issued equity or quasi-equity instruments in qualified portfolio companies as well as equity and quasi-equity instruments in other entities acquired in exchange, it now also includes loans to existing qualifying portfolio companies up to a maximum of 30% of the committed capital, the acquisition of existing shares in qualifying portfolio companies and investments by VC funds-of-funds in directly investing qualifying venture capital funds.
The circle of qualifying portfolio companies has been restricted by the final EuVECA-R language but this should not, however, lead to serious restrictions: Portfolio companies qualify if they are at the time of initial investment unlisted small or medium sized businesses ("SME"), whereupon it is being resorted to the known EU size criteria for SME, i.e. fewer than 250 employees, as well as either an annual turnover not exceeding Euro 50 million or an annual balance sheet total not exceeding Euro 43 million. Such companies must not themselves be an AIF, a credit institution, an investment firm, an insurance undertaking or a (mixed-activity) financial holding company.
The circle of the eligible jurisdictions for the establishment of a qualifying portfolio company comprises the EU Member States and such third countries, which are not non-cooperating countries pursuant to FATF and with which a tax information exchange agreement exists in accordance with the OECD model. Accordingly, this excludes some offshore jurisdictions.
In addition to the aforementioned restrictions on the allocation of funds, target companies and permissible instruments the fund's investment activities are limited to the effect that the "exposure" of the fund at its level must not be increased beyond the undrawn capital commitments and that borrowing, issuing of bonds and provision of guarantees at the level of the fund may only be made up to the amount of undrawn capital commitments.
III. PERMISSIBLE INVESTORS, TEAM INVESTMENT
The circle of eligible investors has been retained from the Commission Proposal, i.e. it still includes professional investors pursuant to MiFID and high net-worth individuals who invest a minimum of Euro 100,000 in the fund.
In the definition of eligible high net-worth private individuals the duty for the Manager has been deleted to assess the knowledge of the investor, which included considerable legal uncertainty and liability risks for the Manager. This is to be welcomed.
Compared to the definition of the semi-professional investor according to the KAGB-E this results in two substantive differences: firstly the minimum investment amount pursuant to the KAGB-E is Euro 200,000. Secondly, the current draft of the KAGB-E continues to provide for the requirement to assess the knowledge of the investor, which has been deleted in the EuVECA-R. It is to be hoped that in the further process the German legislature will align the KAGB-E definition to the EuVECA provisions.
In the EuVECA-R it has been made clear – from legal perspective systematically better than in the KAGB-E – that in case of a subscription by team members of the EuVECA manager no marketing of the fund is taking place. Hence, investments of the team in the funds managed by it are permissible without restrictions.
IV. REGULATION OF THE VC MANAGER
1. Organizational Requirements, Delegation
The EuVECA-R stipulates certain requirements for the internal organization of the Manager, which are very open and leave room for interpretation. The exact definition of those conditions is thus left to the practice. In line with the requirements of the AIFM-D, the Managers must act with due care and diligence, must be properly qualified, must treat its investors fairly and shall ensure that individual investors only obtain such preferential treatment that is set out in the fund documentation, Art. 7 EuVECA-R.
Conflicts of interest must be avoided by appropriate organizational measures or, where they cannot be avoided, must be disclosed, Art. 9 EuVECA-R.
In the final text a provision on delegation of management tasks has been added, Art. 8 EuVECA-R. Pursuant to this the Manager's liability remains unaffected from any delegation and the Manager may not delegate functions in an extent that it becomes a sole "letter-box entity". Further, any delegation may not undermine the effectiveness of supervision of the Manager.
2. Own Funds and Resources
Also in terms of equity capital and human and technical resources, the open wording of the Commission Proposal has been kept: The Manager shall have sufficient own funds and shall use appropriate human and technical resources, Art. 10 EuVECA-R. The "burden of proof" that own funds are sufficient, is imposed on the Managers. It remains unclear why this "burden of proof rule" was not also extended to the human and technical resources. As a result, this is not likely to make any difference, as in all cases it must be demonstrated at the registration that and how the requirements of the EuVECA-R are implemented, Art. 14 EuVECA-R.
On purpose the requirements have been drafted less stringent than the corresponding provisions of the AIFM-D (Art. 9 AIFM-D in conjunction with Art. 12 et seqq. Level-II Regulation); therefore, the only conclusion that can be drawn is that the requirements to be satisfied by a VC-Manager should remain below the requirements of the AIFM.
3. Valuation of Assets
The rules for the valuation of assets must be laid down in the fund documentation and must ensure a sound and transparent valuation process, Art. 11 EuVECA-R. The valuation has to be undertaken at least once a year. As a result, the current market standard, i.e. the valuation and reporting system according to the Guidelines of the IPEV board should meet the requirements set out in the EuVECA-R.
V. TRANSPARENCY REQUIREMENTS
Although the transparency requirements towards current and potential investors as well as supervisory authorities, Art. 7, 9, 12 et seq. EuVECA-R, have been broadened in the final version of the EuVECA-R, it seems possible, however, to comply with such requirements at reasonable efforts.
1. Transparency towards Investors
Towards potential investors Art. 13 EuVECA-R sets out a list of minimum information to be disclosed. These include disclosures regarding the investment strategy and objectives of the fund, the instruments to be invested in, information about the costs and related fees, the risk/reward profile of the investment and the remuneration principles. Going beyond the information that would already today be regarded as necessary for a proper placement memorandum, specifications must also be provided on the extent of the manager's equity capital. In addition, a cap on the costs of the fund must be given.
The EuVECA-R specifically also mentions incubator- and business support services of VC house towards portfolio companies. Hopefully, the German tax legislator finally recognizes that such services are essential activities of VC managers and creates an appropriate tax regime for investors and managers of such funds.
Not surprisingly, the EuVECA-R also regulates the minimum requirements for ongoing reporting, Art. 12 EuVECA-R. This should largely be compliant with the current market standard of a reporting in accordance with the IPEV Guidelines. Further, if applicable, the prospectus requirements must be updated, Art. 13 (2) EuVECA-R.
2. Transparency towards Supervisory Authorities
Towards supervisory authorities, for registration purposes the Manager must submit extensive information which goes beyond the information for the mere registration as small AIFM under the AIFM-D (§ 44 KAGB-E). In addition to specifications regarding the fund and the Manager the information has to include the identity of the directors and how the requirements of the Regulation are being implemented, Art. 14 EuVECA-R. The manager will be registered after an in-depth examination of the submission documents by the supervisory authority of its home country.
As from the registration the manager may market the registered funds as "EuVECA" without restrictions from national placement regimes, Art. 14 para. 3 EuVECA-R.
Marketing of new qualifying funds as well as marketing activities in additional Member States must be notified to the supervisory authority, Art. 15 EuVECA-R.
The Manager must further submit to the supervisory authority annual reports complying with the minimum standards set out by the Regulation, Art. 12 EuVECA-R.
VI. SUPERVISION, CROSS-BORDER COOPERATION
After registration and after each supplementary declaration of new funds as well as the addition of new Member States where marketing is intended, the competent national authority has to notify the supervisory authority of the respective EU Member States, Art. 16 EuVECA-R. The Member State where only marketing activities are undertaken is explicitly prohibited to impose (i) any additional requirements or administrative procedures in relation of the marketing of the EuVECA or (ii) to require any approval of the marketing prior to its commencement.
In contrast, the EuVECA-R contains no prohibition on the further regulation of the management of EuVECA. The EU Member States could therefore extend the regulation to the AIFM-D on these Managers or even provide for more extensive regulation. Pursuant to the AIFM-D such would be permitted. Fortunately, the current draft of the KAGB-E does not provide for further regulation. Manager that comply with the Euro 500 million threshold and that are registered as EuVECA managers are excluded from the KAGB-E, § 2 (6) KAGB-E. However, it is not absolutely certain that this applies as well to Managers that only manage funds the subscription period of which has already expired, i.e. who are not in the fundraising after 22 July 2013. There is hope that it will be clarified in the ongoing legislative process that such Managers as well are not subject to the KAGB-E.
The European Securities and Markets Authority (ESMA) shall maintain a central database, publicly accessible on the internet, listing all EuVECA and their Managers, Art. 17 EuVECA.
Member States are given the typical regulatory and intervention powers to monitor the provisions of the EuVECA-R. ESMA is to ensure a consistent interpretation of the EuVECA-R.
VII. APPLICATION DATE
The EuVECA-R will be applicable as from 22 July 2013, i.e. simultaneously with the end of the transposition period of the AIFM-D.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.