Week 20: Explaining the inexplicable
I <3 GPs. In the words of Mike Tyson, "now kith."
Housekeeping
Welcome to another week of No NDA Required. We’re here to fill the void that exists between emerging fund managers.
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Diving right in and keeping things brief:
On my radar:
Have your portcos apply to Distilled Intelligence here. Be sure to have them name-drop NNR!
If you’re an investor, shoot me an email here and we’ll get you on the ticket pre-order list.
Thinking of putting together an emerging fund manager/VC dinner sometime before summer starts… maybe one in LA and one in NYC? Shoot me an email here if you wanna come!
Putting calls & distractions on hold to go deep into intentional and focused work. I would really love to hear from you with suggestions on how to better manage my time and increase productivity.
Speaking of productivity, we’re getting really close to the end of Q1, which means we’ll have a special edition of NNR soon.
The main idea:
Picking back up…
As a reminder, I am not an attorney, I am just a humble youngling trying to build a venture fund. Please, I beg, do not take anything I say as legal advice. That is what your overpriced attorney is for!
We’ll be picking back up with our discussion around the General Partnership of a venture fund. As a recap from last week:
There are three entities in a fund: the LP (the holder of capital and investments), the GP (the General Partner who receives the 20% carried interest), and ManCo (the Investment Adviser who receives the management fees).
Sunset provisions ensure special LPs in the GP have limited rights, including fees, term length, and control over fund management. This is mostly relevant if your GP and ManCo entity are the same.
Making a GP entity a C-Corp for QSBS benefits doesn’t work—bad idea due to tax and qualification issues. C-corp would lead to double taxation, and investing advisers don’t qualify under the IRS’ definition of an “active business.”
Typically 1-2% of fund size, the GP stake aligns GP incentives with LPs but carries personal financial risk. There are creative solutions if you can’t afford this.
Ensure agreements (LP agreement and GP agreement) allow flexibility for outside (non-conflicting) work and avoid restrictive clauses.
Selling a GP stake before fund DPI is possible if the LPA/GPA permits it, similar to secondaries.
You can read the last edition (part 1) here.
Picking the right registration for the fund
Hopefully that recap makes sense. Let’s dive into the new material:
Allow me to start with context: your venture fund will HAVE to be regulated by some government entity. These rules are mostly focused on keeping LPs safe and making sure you don’t take advantage of unsophisticated investors. Most of these laws come from the Investment Advisers Act of 1940. The goal of this week’s edition is to help you understand what your attorney is talking about when they say something like “you’re an exempt reporting adviser.”
This is the hardest thing I may ever try to explain on this newsletter, but if I do it right, this is a resource that attorneys will send their clients.
There’s an “optimal” situation here, but I want to present all of the options so it makes sense why the “optimal” is actually the best. Bear with me as we run through a ton of definitions to explain. By the end of this, you should have an understanding of the criteria and the benefits of why you are following certain registration protocols. At the end of the day, your fund formation attorney should be handling this process for you, but it never hurts to have an understanding of what they’re talking about.
Starting with the basics
The SEC, and specifically the Investment Advisers Act of 1940 (often called “the Act”), exist to protect the public from scammy money managers and investment advisers. It outlines a set of rules and regulations for almost every financial industry, and every action of that industry. But like all things that government and lawyers get involved in, it became really complicated, really quick. There is plenty that we will not cover here, simply because it isn’t relevant to your mainstream emerging venture fund manager.
This is focused on your “average” or “traditional” Fund I: a few LPs who are friends and family, smaller fund size, no funky structure, and making investments into pre-Series B companies. The Act is smarter than you or I, and any time you shift the model or strategy of your fund, your regulation changes too, so this doesn’t really make a ton of sense for anything outside private equity.
There are a few good terms to know:
An Exempt Reporting Adviser (ERA) is an investment adviser that is exempt from full SEC registration but must still file a limited Form ADV. ERAs fall under two main exemptions:
Venture Capital Fund Adviser Exemption (calling VCA for the sake of brevity) is for advisers who manage only venture capital funds. It is defined by Section 203(l) of the Investment Advisers Act of 1940.
Private Fund Adviser Exemption (calling PFAE here) is for advisers who manages < $150M in private fund AUM in the U.S.). It is defined by Section 203(m) of the Investment Advisers Act of 1940.
A Registered Investment Adviser (RIA) is an investment firm or individual fully registered with either the SEC or state regulators. RIAs operate under strict fiduciary responsibilities and must adhere to extensive compliance and reporting requirements, including filing Form ADV, maintaining accurate records, following advertising regulations, and undergoing periodic regulatory examinations. Unlike Exempt Reporting Advisers (ERAs), RIAs have no AUM restrictions and can serve a broad range of clients, including retail investors, institutional clients, and public funds.
A Private Fund is usually any pooled investment entity relying on the 3(c)(1) or 3(c)(7) exemption under the Investment Company Act. Most standard venture funds fall in this category.
When talking about state registration and filings, it’s important to know the term “Blue Sky Laws.” These are state securities laws that regulate offerings, sales, and adviser activities within each state, often requiring notice filings or state registrations if you are not federally preempted.
The SEC’s core registration and disclosure document is called Form ADV. Part 1 is data-driven (including “Exempt Reporting Adviser” items). Part 2 is the narrative “brochure” you share with clients. ERAs file a scaled-back version, while RIAs file the full form.
The Form ADV is filed with an organization called the IARD (Investment Adviser Registration Depository). The IARD is sponsored by the SEC and the NASAA, and is the “centralized” filing agency. They share your filings with the relevant government orgs.
Registering is a formal process that comes as a result of filing. When you are registered, that body actually has supervisory oversight and governing power over you. Think about the R in RIA — they have to follow the SEC’s rules and regulations in huge detail.
Filing, or Notice Filing, is just declaring that you exist. You can be filed and not be registered, but to be registered you must file. In many cases in this article, you would be filing for an exemption, which is just filling out a form that basically says, “hey I exist, but here is why you don’t have to worry about me.”
Okay, now getting into some of the details that matter here. Hopefully those definitions make sense, and we can start applying them.
VCA Exemption
The VCA exemption is what most venture funds rely on, especially as they grow. It is important to make sure you adhere to this criteria, and many LPs will want to make sure you're doing so by setting really clear guardrails in your LPA and GPA.
The Venture Capital Adviser (VCA) Exemption is defined under SEC Rule 203(l)-1 of the Investment Advisers Act of 1940. It sits as a “subcategory” or “type” of ERA. When you’re filling out the Form ADV, and you’re big enough of a fund to think about filing for exemptions, the VCA Exemption box is the one most fund managers will want to check. To qualify, you must qualify with the following:
The Fund must invest at least 80% of its capital in private operating companies that do not trade on public markets. These companies must primarily operate a business, so funds (including SPVs) may not qualify under this 80% unless they meet the SEC’s definition of a “qualifying portfolio company” by being a pass-through entity.
The fund cannot borrow or guarantee debt exceeding 15% of total fund capital. Any debt must be less than 120-day loans.
There cannot be redemption rights, meaning LPs cannot withdraw capital on demand (i.e., no hedge fund-style liquidity). Their money has to be locked up for the entire fund cycle, usually 7-10 years.
The fund must explicitly market itself as a “venture capital fund” to investors.
A max of 20% of the fund’s assets can be in non-qualifying investments (e.g., public companies, secondary sales, cryptocurrencies, other funds).
Why do so many fund managers want the VCA designation given that it is so limiting to being a traditional venture fund? The advantages of the VCA exemption over the more flexible Private Fund Adviser Exemption are pretty noticeable:
There is no AUM limit, like the $150M AUM cap that exists for PFAs.
Not subject to any SEC examinations, whereas PFAs may be subject to the occasional SEC examination.
Institutional LPs may prefer VCA due to friendliness by the SEC and states — it’s pretty darn well recognized and accepted for venture funds. So long as you follow the rules, things should be pretty clear-cut.
But now this begs the question — when the hell do you even have to start worrying about this? It’s important to know in the early days, because you have to plan to stay compliant as your fund grows and evolves. Remember: these exemptions are determined at the ManCo level, NOT the fund level. So your early funds can really impact things for you down the line.
The annoying wrench in this situation is that while you have to mentally try to keep VCA in the back of your head, it doesn’t really come into play until you hit certain thresholds. The most immediate “oh yeah, now it matters” triggers are a) operating or having LPs in 15+ states or b) hitting over $100M in AUM. Of course, like all things in law, there are nuanced situations that would cause you to have to register for exemption sooner, but you can usually only register with the states until one of those two things happen.
The filings
So in practice, you (well not you, it’s usually your attorney) will have to file a Form ADV once a year. The Form ADV gets reported to the IARD, so the information you fill out there goes to both the SEC and the states. There are a few options on how you can fill it out:
Ignore the SEC boxes and register with the states (ideal for small funds).
Just register with the SEC and ignore the states.
File for exemption with the SEC and maybe still register with the states, depending on state rules (ideal for big funds).
There are more options, obviously, but these are the most common. Now let’s use this flow chart (that took me a million years to make) to help you figure out what your ADV will probably look like:
You can view & download the PDF form here. As always, this is a simplification and you should defer to your fund formation attorney.
Hopefully, this makes sense. Moral of the story is: how you register depends on a few factors:
Are you operating in 15+ states in a way that you would have to be registered in 15 states? If yes, then you always have the option to ditch state registration under SEC Rule 203A‑2(d).
What is your AUM? Over $100M, you have to worry about the SEC. Between $25-100M, you might have to worry about the SEC. Under $25M, the SEC doesn’t even want to think about you. You’ll likely always be dealing with the states, though.
What kind of assets are you invested in? Traditional VC?
A bunch of other factors like debt, leverage, liquidity rights, etc.
The ADV
So what does all of this actually look like in practice? Take a look at the Form ADV Part 1. Regardless of who you are, you MUST file a Form ADV. The Form ADV gets reported to the IARD, who then distributes it to either the SEC or your state depending on the information that you filled out.
If you are registering as a venture capital fund between $0-25M that has to only register with 1 state, then you would fill out the ADV with the IARD to register with the state, and not file anything at the SEC level.
If you are registering as a private equity fund at $125M in 16 states, you could either:
a) register with the SEC and totally skip all state registration, or:
b) file with the SEC as an ERA (PFA exemption) and then register with the 16 states.
There are what feels like infinite options on how and where to file — this is where your attorney becomes helpful.
If you want more comprehensive guides (that I think are more legalese and probably harder to understand), I would check out Strictly Business and/or MoFo’s guides on this.
I’m sure I’ll make amendments to this post on Substack as readers suggest corrections for mistakes, so bookmark this for up-to-date changes!
There are two other little tidbits of compliance I want to include here, because I think they are important for emerging managers to know. Again — gross simplification to just put it on your radar, and you should talk to your fund attorney and fund admin about these:
What is ERISA?
ERISA, or the Employee Retirement Income Security Act of 1974, is a federal law that regulates pension funds, retirement plans, and other employee benefit programs to protect plan participants. It enforces strict fiduciary responsibilities on those managing these assets, requiring them to act in the best interests of beneficiaries.
For VC funds, ERISA is significant because pension funds and retirement accounts are often key LPs or anchor LPs. If too much ERISA-regulated capital flows into a fund, the fund itself may become subject to ERISA’s fiduciary rules — imposing significant investment restrictions.
To avoid this, funds must either qualify as a Venture Capital Operating Company (VCOC) or ensure that ERISA investors hold no more than 25% of the fund’s total assets — the “25% ERISA Plan Assets Rule.” If ERISA investors exceed that threshold, the entire fund is classified as holding ERISA plan assets, making the GP an ERISA fiduciary, with all the compliance burdens that come with it.
VCOC Compliance
Venture Capital Operating Company (VCOC) status allows VC firms to avoid ERISA (Employee Retirement Income Security Act) fiduciary & reporting restrictions when managing ERISA-qualified (like pension plan) money.
To qualify, a VC fund must have at least 50% of portfolio investments to be in active businesses with management rights. This is determined at the fund/vehicle level, so you can have one vehicle (like a general fund) that is VCOC compliant, but then an SPV or another vehicle/fund that isn’t compliant.
An important tool to stay VCOC compliant is a Management Rights Letter (MRL) because it gives the “management rights.” An MRL typically gives the investor the ability to access financials, have a board seat or board observer, consult on strategic decisions, and tour facilities or meet with management. It’s absolutely normal for a major investor to ask for and get an MRL in most rounds.
This is especially important for early investments or those that you may plan to warehouse into the fund, as it could pose an obstacle for ERISA LPs coming into the fund if an MRL is missing. It can sometimes be hard to get an MRL after the investment is closed as negotiating leverage disappears after the transfer of cash.
Next time: maybe a quick dive into side letters and the differences between 3(c)(1) vs. 3(c)(7) structures—and maybe we’ll even talk about marketing your fund under 506(c) and the new changes?
Headlines
The biggest news: NEW NO ACTION LETTER ON 506(C). Funds no longer have to verify accreditation if generally soliciting, according to this. This will probably be a whole edition next week.
Hinge Health filed their S-1 to go public.
Whoop and Solidcore just announced a partnership to measure & track Solidcore workouts.
Susa Ventures just announced Fund V at $175M.
The Angel Group made an 88x on their $105k investment into Poppi.
Oh, on that note, Poppi got acquired by Pepsi for $1.95B (which includes $300M in cash tax benefits).
Kiva explains this $300M cash tax benefit clearly here.
Cendana Capital just announced Fund 6 at $400M. They said it was “our fastest fundraise ever, and had interest well above our $400M hard cap.” Flex.
Wiz is finally getting acquired by Google for $32B, which is an insane valuation premium. Literally they were at a $12B val in May 2024. Wish I bought forward contracts for it…
Rippling sued the living shit out of competitor Deel over claims that they had embedded a spy into Rippling. According to Parker Conrad (Rippling CEO)’s post on X: “The spy searched “deel” in our systems 23 times per day on avg, letting him spy on Deel’s own customers who were considering a switch to Rippling.” Holy shitsicles if true.
Sweetgreen opened its 250th store in Richmond, VA. It might start raining kale pretty soon.
X’s valuation is up to $44B, a big jump from the $10B valuation in September.
Apple TV+ (their streaming) is losing over $1B a year. The streaming wars are a losing proposition, in my opinion.
CoreWeave is looking to IPO at about $30B (they JUST filed their S-1).
Nvidia acquired a company called Gretel.
Amazon might be releasing some new hardware to take advantage of the AI-enhanced Alexa.
xAI has acquired Hotshot, a text-to-video startup.
Sequioa is shutting down their DC office.
Tesla just got their robotaxi permit in CA, right as Waymo begins training for SFO.
Icing on the Cake:
Distilled Intelligence! Want to raise money? Come to Distilled Intelligence. Want to source great companies? Come to Distilled Intelligence. Want to help your portcos succeed? Tell them to come to Distilled Intelligence.
Some cool stuff on my radar
I’ve been using & loving my Peak Design 20L this week — man it’s good. Anyone who knows me knows how much I love my Tumi backpacks, but this just feels geeky and over-engineered in a way that gives me the fuzz.
Starting something I hope to do often (maybe weekly)… honest pocket dumps of what I’m carrying each week. The goal is to help you find cool new pieces of EDC. Here is this week’s pocket dump:
Thinking about getting back into running, and these Craft shoes really caught my eye. Anyone else have recs for a mid-distance training shoe? This looks to be too race for my cup of tea.
Just putting it out there that Metolius makes the best carabiners. I finally broke one yesterday after what must be 10+ years of hard use.
I am on the hunt for a snazzy summer shoe and came across the Astorflex. Looks to be a little bit more robust of a build than the Sabahs. Will keep you updated if I cop.
Drooling over this Bamford x Land Rover titanium watch.
Closing
Thanks for taking time out of your Wednesday to read.
As always, you can find me on X and LinkedIn, and I’d love to hear from you via email. Whether it’s talking startups or just shooting the shit, I’m always happy to connect.
Onto the next!
//Eli