i GENERAL OVERVIEW

Given the continuing excellent performance of the private equity fund industry,2 private equity fundraising has remained very strong even though it slowed down in 2019 as compared with prior years.3 In fact, fundraising has been so strong over the past few years that CNBC has reported that at the end of 2019, the private equity fund industry was sitting on US$1.45 trillion in dry powder.4 This is the highest on record and more than double what it was just five years ago.5 This amount of dry powder has increased competition for deals and has delayed the deployment of capital by private equity funds given high valuations this late in the cycle.6 As a result, some investors have expressed concerns about returns going forward and investors generally intend to commit less fresh capital to private equity funds over the next 12 months.7 As a result, it is more critical than ever for fund managers to differentiate themselves in this market to attract investments from investors.

ii LEGAL FRAMEWORK FOR FUNDRAISING

i Formation considerations

The selection of the jurisdiction for the establishment of a private equity fund will depend, in part, upon the types of investors the fund sponsor contemplates soliciting. For instance, if the investors are expected to be comprised exclusively of US investors, the fund manager will tend to select a US-domiciled fund to match the fund's jurisdiction with that of its investors. If, instead, non-US investors are also expected to invest in the fund, the fund sponsor may allow these investors to invest in its US-based fund or may, if the investors would prefer a non-US domiciled vehicle, offer a fund established in a non-US jurisdiction (e.g., the Cayman Islands) to these investors that would invest on a parallel basis with the US-domiciled fund. Further, if the investors are from Europe, the fund sponsor may opt to create a European-domiciled fund (e.g., a fund formed in Luxembourg or Ireland).

Private equity funds are generally formed as limited partnerships. For US-domiciled funds, it is very typical to form the fund in the state of Delaware and this is by far the leading jurisdiction for the formation of US-based investment funds. A couple of factors have contributed to Delaware's dominance in this area. Delaware has very flexible statutes that respect freedom of contract and maximise the ability of the parties to a contract to reflect the terms of their agreement. In addition to this statutory advantage, Delaware provides specialised courts for business entities, which can bring a significant amount of expertise and thoughtfulness to any disputes that may arise under the fund's governing document. It is also relatively inexpensive to form a fund in Delaware and there is a substantial industry of service providers in Delaware that will facilitate the formation and maintenance of a Delaware entity. While we do sometimes see US-domiciled private equity funds formed as Delaware limited liability companies, we view this as less common due, in part, to the less developed case law around limited liability companies given the statute is relatively new and more significantly due to the fact that some non-US jurisdictions may tax an LLC as a corporation, thus, making a limited liability company less ideal than a limited partnership for non-US investors that would otherwise be comfortable investing in a US flow-through entity.

In terms of non-US private equity funds, the Cayman Islands is one of the leading non-US jurisdictions for private equity funds. It enjoys its leading status due, in part, to an excellent roster of service providers in the jurisdiction and very flexible statutes that have been modelled after Delaware law to a large degree. Some investors, particularly those resident in certain countries in Europe, may not be able to invest in a fund based in a Caribbean tax haven such as the Cayman Islands. Instead, these investors may only be able to invest in a fund domiciled in a European jurisdiction such as Ireland or Luxembourg. However, the costs and ongoing regulatory burdens associated with managing a European-domiciled fund (particularly for fund managers that are not already subject to these obligations) can be quite extensive. As a result, fund managers that are seeking to receive capital commitments from these investors generally will need to consider whether there is sufficient interest from other similarly situated European investors to justify the additional cost incurred by the fund manager with respect to the operation of a parallel fund for these investors.

With regard to the tax treatment of a private equity fund, the general goal, unless other circumstances dictate a different result, is to give the investors flow-through tax treatment all the way down to the underlying portfolio investments. There could be tax reasons why that may not be ideal from an investors' perspective. For instance, a non-US investor may be worried that such tax treatment with respect to a US investment may create a need to file a tax return in the US, a result many non-US investors seek to avoid. This is often the case in private equity funds operated by US-based private fund managers that conduct a direct lending fund strategy. In addition, a US tax-exempt investor may prefer to avoid 'unrelated business taxable income' generated from one or more of the fund's portfolio investments. To eliminate these adverse tax consequences for such investors, the fund manager generally will create what are known as 'alternative investment vehicles' that are either subsidiary entities of the fund or parallel vehicles to which investors of the main fund contribute capital directly for a single investment.

ii Disclosure matters

As one might expect, the offering of an interest in a private equity fund constitutes the offering of a security under the US securities laws. To comply with all of the fund manager's obligations under the US securities laws, the fund manager must provide disclosure of all material facts to an investor in connection with the offering of interests in the fund. This is commonly stated as a duty to ensure that the offering documents do not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. Because the fund manager and its control persons can have personal liability for a violation of this duty, fund sponsors are very careful and thoughtful with respect to the disclosure set forth in an offering document. In this respect, some significant items that must be studied closely are whether the disclosure regarding the investment strategy and the discussion of the risk factors and conflicts of interest encompass all of the material considerations associated with the fund manager's business and the particular strategy to be conducted by the fund manager with respect to the fund.

Another area where fund counsel and the fund manager spend a considerable amount of time relates to the presentation of the prior performance track record of the fund manager contained in the pitch book or the offering document of the private equity fund to be managed by the fund manager. One must confront the following issues.

  1. How portable is the track record (e.g., if the fund manager is newly established and its track record is derived from the fund manager's investment team at a prior investment management firm)?
  2. Does the manager have sufficient supporting documentation to justify the use of the track record?
  3. Is the new private equity fund's strategy substantially similar to the strategy that generated the prior track record?
  4. Are all of the material assumptions associated with the track record set forth in the performance presentation?

It is important for fund counsel and the fund manager to comb through the disclosure in the pitch book and offering document to ensure appropriate items are footnoted and that there are no promissory or superlative statements.

iii Solicitation of investors in the United States

General prohibition

The general rule governing US securities offerings specifies that:

[u]nless a registration statement is in effect as to a security, it shall be unlawful for any person, directly or indirectly to make use of any means or instruments of transportation or communication in interstate commerce or of the mails to sell such security through the use or medium of any prospectus or otherwise; or to carry or cause to be carried through the mails or in interstate commerce, by any means or instruments of transportation, any such security for the purpose of sale or for delivery after sale.8

Exception for private placements by an issuer

Section 4(a)(2) of the US Securities Act of 1933 (the Securities Act) specifies that the provisions of Section 5 'shall not apply to [t]ransactions by an issuer not involving any public offering'. To provide the industry with further guidance regarding this exception, the US Securities and Exchange Commission (SEC) crafted Regulation D, which was a safe harbour intended to provide detailed guidance regarding Section 4(a)(2). Given that Regulation D is a safe harbour, an offering made in accordance with Regulation D is deemed to comply with Section 4(a)(2). Private equity funds typically rely on Rule 506 of Regulation D since it contains no dollar limitation on the amount of capital that may be raised, unlike other rules set forth in Regulation D. Rule 506 provides for two separate ways to conduct the offering. One is pursuant to Rule 506(c), which allows a fund manager to publicly offer interests in a private equity fund. Rule 506(c) is a very new rule (adopted in 2013) that the SEC was obligated to adopt in connection with the passage of the Jumpstart Our Business Startups Act, or JOBS Act. Alternatively, a fund manager can rely on Rule 506(b), which is the private placement exemption on which private equity fund managers have typically relied to raise capital for their funds. Due, in part, to the heightened regulatory scrutiny associated with Rule 506(c) offerings, virtually all private equity fund managers raise capital for their funds pursuant to Rule 506(b) and, as a result, this article will not delve into the specific requirements of Rule 506(c).

Rule 506(b) provides that an offering is deemed to comply with Section 4(a)(2) if (1) sales are made only to accredited investors,9 (2) the issuer does not engage in a general solicitation or advertising with respect to the securities offered and (3) the accredited investors acquire the securities for investment and not for resale. Notwithstanding the foregoing, it should be noted that Rule 506 permits the sale of securities to up to 35 non-accredited investors with additional disclosure to such investors. However, as a practical matter, private equity funds typically only accept accredited investors. In addition, Regulation D requires an issuer to file a Form D with the SEC within 15 days of the first sale of interests to US investors.

An additional requirement implicated in connection with a Rule 506 offering is compliance with the 'bad actor' rules set forth in Rule 506(d) of Regulation D. These rules disqualify securities offerings that involve certain felons and other bad actors from relying on Rule 506 of Regulation D where an issuer or specified covered persons10 have had a disqualifying event11 in the past.

Manner of offering

One of the more significant requirements of Rule 506(b) is the prohibition on general advertising and solicitation.12 Essentially, this requires that the fund manager must have a substantive pre-existing relationship with a potential investor in order to solicit such investor. In other words, the fund manager must have adequate knowledge of that offeree's financial circumstances and sophistication to establish that he or she is an eligible investor for the offering. A private equity fund manager can establish this level of relationship with a prospective investor in one of two ways. A representative of the fund manager might approach a prospective investor and inquire about the investor's financial circumstances and sophistication. As part of this process, the fund manager will request that the investor complete a questionnaire that contains various questions seeking to identify the investor's financial net worth and general level of sophistication with respect to investment matters. After continuous contact with the prospective investor for a sufficient period of time (the SEC has provided guidance indicating that a 45-day period could be sufficient), the fund manager may distribute offering materials for a fund to such investor without violating the prohibition on general advertising and solicitation. Alternatively, the fund manager may engage a placement agent to solicit prospective investors with whom the fund manager does not have a substantive pre-existing relationship. By doing so, the fund shall be deemed to have a substantive pre-existing relationship with any prospective investor with whom the placement agent has such a relationship. Although this is beyond the scope of this article, it should be noted that to the extent a US registered broker-dealer is engaged by a fund manager to solicit investors on behalf of a fund, the rules of the US Financial Industry Regulatory Authority will apply to the offering and will need to be considered.

Section 15 of the US Securities Exchange Act of 1934 (the Exchange Act) prohibits any person from engaging in the business of acting as a broker or a dealer unless such person is registered with the SEC as a broker-dealer or an exemption from such registration is available. If a private equity fund sells its securities to US persons directly, rather than through a placement agent that is a registered broker-dealer, the question arises whether anyone acting on behalf of the fund needs to register with the SEC as a broker-dealer. Rule 3a4-1 of the Exchange Act provides a non-exclusive safe harbour from such registration if certain requirements are met. Although the precise analysis under Rule 3a4-1 can be complex, very generally, if the persons acting on behalf of the fund (which may be officers and directors of the investment manager or general partner of the private equity fund) (1) are not subject to a statutory disqualification from acting in such capacity, (2) provide services to the fund manager other than solely capital-raising assistance, (3) are not affiliated with a registered broker-dealer and (4) do not receive commissions or other sales-based compensation for the sale of interests in the fund manager's private equity funds, the fund manager may elect to take the position that it can rely on the Rule 3a4-1 safe harbour. This is a very fact-specific analysis so fund managers and their counsel will need to carefully consider the factual circumstances before making this determination.

iv Solicitation of non-US investors

To the extent the US fund manager is seeking to solicit non-US investors for its non-US private equity fund, Regulation S (instead of Regulation D) becomes the applicable US offering rule with which the fund manager must comply. With respect to the Section 5 prohibition referenced in footnote 8, through the Regulation S safe harbour, the SEC generally takes the position that the registration requirements of the Securities Act do not apply to offers and sales of securities made outside of the United States when such offers and sales are made with only incidental US contacts and are made in a way reasonably designed to preclude the redistribution of the securities in the United States. A typical non-US private equity fund complies with Regulation S by satisfying the requirements of Rule 903(a) under Regulation S, which requires that the offer or sale is made in an offshore transaction13 and no directed selling efforts are made in the United States by the issuer or any person acting on behalf of the issuer.

v Negotiation of legal terms

Given investors in a private equity fund are often locked into the investment in the fund for at least 10 to 12 years without any right to redeem from the fund, the governing document of a private equity fund is typically heavily negotiated and detailed. As a result, prospective investors often focus closely on the corporate governance aspects of the overall arrangement. For instance, (1) do the investors have an ability to suspend or terminate the fund manager's ability to make new investments, (2) do the investors have a right to terminate the fund or remove the general partner of the fund (either for cause or without cause) and (3) is there an advisory committee comprised of representatives of limited partners that looks after the interests of the investors? There are often many discussions around these general concepts. Investors also focus on the economic terms offered by the fund. In addition to the management fee and carried interest mechanics, which are often scrutinised, investors also analyse the limited partners' obligations to return distributions to the fund (i.e., a limited partner giveback provision) and the general partner's obligation to return any carried interest it received in excess of what it was entitled to receive under the private equity fund's partnership agreement. There are a multitude of other concepts covered in negotiations with investors. Some of these concepts are derived from private equity principles developed by the Institutional Limited Partners Association (ILPA).14 It would be prudent for fund managers seeking to raise capital to familiarise themselves with these ILPA principles and compare their fund terms and conditions against those recommended in the ILPA principles.

III REGULATORY ASPECTS

i Regulation of the fund

A typical private equity fund would fall within the definition of an investment company because the majority of its assets are investment securities for purposes of the US Investment Company Act of 1940 (the Investment Company Act). However, private equity funds generally have two exceptions to investment company status on which they can rely. One is set forth in Section 3(c)(1) of the Investment Company Act (a fund relying on Section 3(c)(1), a '3(c)(1) Fund') and the other is set forth in Section 3(c)(7) of the Investment Company Act (a fund relying on Section 3(c)(7), a '3(c)(7) Fund'). A 3(c)(1) Fund must not make or propose to make a public offering of its securities (e.g., offering its securities pursuant to Rule 506(b) or 506(c) of Regulation D would not be a public offering) and must not have more than 100 beneficial owners. While a 3(c)(7) Fund does not have a numerical limit on the number of beneficial owners it may have under the Investment Company Act, all of its beneficial owners must be 'qualified purchasers'.15 A 3(c)(7) Fund must also not make or propose to make a public offering of its securities. Although beneficial ownership by an entity would typically be deemed beneficial ownership by a single person, it should be noted that the Investment Company Act and guidance issued thereunder contain 'look-through' rules that would require one to disregard the investing entity and analyse the entity's underlying beneficial owners for purposes of determining whether the private equity fund has more than 100 beneficial owners or whether the fund is owned exclusively by qualified purchasers.

ii Regulation of the fund manager

General rule regarding investment adviser registration

The investment manager of a private equity fund will likely fall within the definition of an 'investment adviser'16 under the US Investment Advisers Act of 1940 (the Advisers Act). If the fund manager is not registered with the SEC as an investment adviser, the fund manager will also need to consider whether it needs to register with the applicable state or states in which it conducts its investment advisory activities. Finally, to the extent the fund manager utilises certain derivatives or other commodity interests in connection with its business, it will need to determine whether it may need to register with the US Commodity Futures Trading Commission (CFTC) as a commodity pool operator or commodity trading adviser, or as both.

Private fund adviser exemption

The SEC exempts from registration as an investment adviser an investment adviser that provides investment advice solely to private funds17 and that has less than US$150 million in regulatory assets under management18 in the United States. For US-based investment advisers, all of their regulatory assets under management generally will count towards this US$150 million threshold. However, in the case of an investment adviser with a principal office and place of business outside of the United States (a non-US adviser), the exemption is available as long as all of the non-US adviser's clients that are US persons are 'qualifying private funds'19 and the non-US adviser manages less than US$150 million in private fund assets from a place of business in the United States. In other words, so long as a non-US adviser has no place of business in the United States and to the extent its only clients that are US persons are private funds, it will not be required to register under the Advisers Act regardless of the amount of private fund assets under management attributable to US private funds.

Foreign private adviser exemption

There is also an exemption from SEC registration under the Advisers Act specifically applicable to 'foreign private advisers'. A foreign private adviser is an investment adviser that: (1) has no place of business in the United States; (2) has, in total, fewer than 15 clients and investors in the United States in private funds advised by the investment adviser; (3) has aggregate regulatory assets under management attributable to clients in the United States and investors in the United States in private funds advised by the investment adviser of less than US$25 million; and (4) neither holds itself out generally to the public in the United States as an investment adviser nor acts as an investment adviser to an investment company registered under the Investment Company Act or to a company that has elected to be treated as a business development company pursuant to Section 54 of the Investment Company Act. With respect to this exemption, the term 'place of business' means an office at which the investment adviser regularly provides advisory services, solicits, meets with or otherwise communicates with clients, and any location that is held out to the general public as a location at which the investment adviser provides investment advisory services, solicits, meets with, or otherwise communicates with clients.

Venture capital fund exemption

A fund manager that provides investment advice exclusively to venture capital funds can rely on a separate exemption from registration as an investment adviser. To qualify for this exemption, each fund advised by the fund manager must qualify as a venture capital fund,20 which is a private fund that (1) represents to investors that it pursues a venture capital strategy, (2) does not provide investors with redemption rights or other similar liquidity rights except in extraordinary circumstances, (3) holds, immediately after the acquisition of any asset, other than 'qualifying investments'21 or short-term holdings, no more than 20 per cent of the amount of the fund's aggregate capital contributions and uncalled committed capital (total capital) in assets (other than short-term holdings) that are not qualifying investments, (4) does not borrow, issue debt obligations, provide guarantees or otherwise incur leverage in excess of 15 per cent of the fund's total capital, and any such borrowing, indebtedness, guarantee or leverage is for a non-renewable term of no longer than 120 calendar days (except for certain portfolio company guarantees that may exceed this time limit, as described below), and (5) is not registered under the Investment Company Act and has not elected to be treated as a business development company.

State regulation

To the extent the fund manager is able to avail itself of an exemption from SEC registration, the fund manager will likely need to consider whether it is obligated to register with any state in which it conducts its advisory activities. This will require a careful analysis of the applicable state securities laws to determine whether there may be an exemption from such registration or whether registration is required. Some states may not require registration of private fund managers or may only require registration once the number of funds such manager manages exceeds a certain threshold.

CFTC regulatory status

Although a private equity fund manager is unlikely to utilise futures like that of a hedge fund manager, a private equity fund manager may seek to utilise certain types of derivative instruments (e.g., swaps) that hedge risks at the fund level such as foreign exchange risk or interest rate risk. To the extent these instruments constitute commodity interests for purposes of the rules and regulations of the CFTC, the private equity fund manager will have to consider whether it is required to register with the CFTC as a commodity pool operator (CPO) or a commodity trading adviser (CTA), or as both, or whether it can avail itself of an exemption.

To the extent the private equity fund manager can utilise commodity interests within a specified de minimis exemption, the fund manager can avoid registration with the CFTC as a CPO and CTA. This de minimis exemption from CPO registration is set forth in CFTC Rule 4.13(a)(3) and requires that (1) the private equity fund is privately offered, (2) the private equity fund only engages in a de minimis amount of trading in commodity interest positions,22 (3) the private equity fund is not marketed as a vehicle for trading in the commodity futures or commodity options markets and (4) the investors of the private equity fund are non-US persons (as defined in the CFTC regulations) or accredited investors (as defined in Regulation D of the Securities Act).

With respect to non-US fund managers, there are additional CPO exemptions that may be applicable to such managers. These exemptions are set forth in CFTC Rules 3.10(c)(3), 30.4(c) and 30.5. CFTC Rule 3.10(c)(3) is generally the most popular CPO exemption for non-US fund managers because it is the only one of these exemptions that permits the private equity manager to engage in the trading of commodity interests on US exchanges, which, given the depth of the US trading markets, is generally preferred. To qualify for CFTC Rule 3.10(c)(3), (1) the CPO must be located outside of the United States, (2) the private equity fund and its investors must all be located outside of the United States and (3) the private equity fund trades commodity interests on US exchanges.

To the extent a fund manager can avail itself of an exemption from CPO registration, the fund manager can often find an exemption from CTA registration as well. One common exemption is set forth in CFTC Rule 4.14(a)(5), which provides an exemption from CTA registration if the fund manager is exempt from registration as a CPO and such fund manager's 'commodity trading advice is directed solely to, and for the sole use of, the pool or pools for which it is so exempt'.

To the extent a fund manager is unable to satisfy an exemption from either CPO or CTA registration, the fund manager will likely be required to register with the CFTC in such capacity. This generally will mean that such fund manager will need to operate each private equity fund it manages that is outside of any applicable CFTC exemption pursuant to CFTC Rule 4.7. CFTC Rule 4.7 is only able to be utilised by registered CPOs and it allows a registered CPO to comply with less burdensome disclosure, record-keeping and reporting requirements than would otherwise apply in light of the fact that the investors in the commodity pool are more sophisticated (i.e., 'qualified eligible persons').23

Current regulatory considerations

The recently passed Tax Cuts and Jobs Act in the United States imposes a three-year holding period for eligibility for investment managers to be taxed at long-term capital gains rates on their carried interest (i.e., the share of partnership profits received by a fund manager in an investment fund). If this three-year requirement is not met, the carried interest allocation would be taxed as short-term capital gain subject to a top marginal rate of 37 per cent. It is currently uncertain how this will impact the private equity fund industry. Many private equity fund managers have historically held many (if not most) of their investments for at least three years. Others may consider whether there is any way to ameliorate this tax consequence through adjustments to the fund's governing documentation.

At the state level, the governor of the state of New York has recently proposed a 17 per cent 'fairness fix' tax on hedge fund and private equity managers' compensation. This tax is intended to reflect the difference between a 20 per cent federal rate that such earnings often qualify for and the top 37 per cent rate it would face if it were treated as ordinary income. Because this measure would take effect only if Connecticut, Pennsylvania, Massachusetts and New Jersey enact similar legislation, it is unclear whether this proposal ultimately will be implemented.

At the federal regulatory level, the SEC recently released its examination priorities with respect to investment advisers. Although no one expects the SEC to ignore private equity fund managers, there does seem to be a move away from a focus on private fund managers to protection of retail investors and these inspection priorities are consistent with that construct.

IV OUTLOOK

The private equity fund industry has been through a great deal in the past 10 years or so. There was a financial crisis in 2008–2009, followed by a global increase in regulation. This has resulted in the obligation of many private equity fund managers to register with the SEC and, in some cases, the CFTC, as well as regulators in other jurisdictions, and their policies and procedures have been scrutinised through routine examinations. Ultimately, private equity fund managers have effectively weathered these developments and have generated high returns over the past decade. While valuations in the private equity market are perceived as high by some investors, investors continue to seek out private equity funds for their ability to provide protection when the economy or the public markets suffer a downturn. Accordingly, private equity fund managers will likely continue to have success raising capital for their funds while utilising the significant amount of dry powder they hold in reserve should the inevitable pullback in the markets appear.


Footnotes

1 Kevin P Scanlan is a partner at Kramer Levin Naftalis & Frankel LLP.

2 Based on the Preqin quarterly update for Q3 2019, private equity funds of vintage 2010 onwards have consistently produced median net internal rates of return above 14 per cent, reaching a high of 15.5 per cent for vintage 2012 funds.

3 Based on Preqin's 2019 Private Equity & Venture Capital Fundraising & Deals Update, the number of funds closed in 2019 was down 26.5 per cent as compared with 2018, although this equated to only a 5.25 per cent reduction in the aggregate capital raised in 2019 versus 2018.

4 'Private equity's record $1.5 trillion cash pile comes with a new set of challenges', CNBC.com (3 January 2020).

5 id.

6 Based on Preqin's 2019 Private Equity & Venture Capital Fundraising & Deals Update, the number of private equity-backed buyout deals in 2019 was down 21.26 per cent against 2018 and the aggregate deal volume in 2019 decreased by 20.28 per cent against 2018.

7 The Preqin quarterly update for Q3 2019.

8 Section 5 of the US Securities Act of 1933.

9 Very generally, accredited investors are natural persons with a net worth (excluding the value of their primary residence) of US$1 million and entities with total assets of US$5 million.

10 Although the list of covered persons is too long to set forth in this footnote, covered persons include (1) the issuer seeking to sell securities under Rule 506, (2) any director, executive officer or other officer participating in the offering, (3) any beneficial owner of 20 per cent or more of the issuer's voting equity securities and (4) any investment manager to an issuer that is pooled investment fund.

11 Disqualifying events include, among other things, criminal convictions, final orders of certain state and federal regulators, SEC disciplinary orders and SEC stop orders.

12 Examples of general advertising and solicitation include, without limitation, cold calling or mass mailing or communications published in any newspaper, magazine or similar media, or broadcast over television or radio.

13 An offshore transaction is a transaction in which the offer or sale of the fund's interests is made to a person outside of the United States and the buyer is offshore at the time of the origination of the buy order.

15 The definition of 'qualified purchaser' is set forth in Section 2(a)(51)(A) of the Investment Company Act and includes, among other things, a natural person with an investment portfolio of US$5 million and an institution with an investment portfolio of US$25 million. There are special rules in this regard for trusts.

16 An 'investment adviser' is defined as a person that (1) for compensation, (2) engages in the business of advising others, (3) as to the advisability of investing in, purchasing, or selling securities. See Section 202(a)(11) of the Advisers Act.

17 A 'private fund' is defined as any issuer that would be an investment company under the Investment Company Act but for the exceptions set forth in Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act.

18 The term 'regulatory assets under management' is the sum of the value of all securities portfolios with respect to which the adviser provides investment advisory services.

19 A 'qualifying private fund' means any private fund that is not registered under Section 8 of the Investment Company Act and has not elected to be treated as a business development company pursuant to Section 54 of the Investment Company Act.

20 It should be noted that a fund manager relying on the venture capital fund adviser exemption may also advise one or more investment vehicles licensed by the Small Business Administration, otherwise known as SBICs, without running afoul of this exemption.

21 A 'qualifying investment' is generally an equity investment in a qualifying portfolio company. A 'qualifying portfolio company' is any company that: (1) at the time of any investment by the venture capital fund, is not a reporting company or foreign traded and does not control, is not controlled by, or is not under common control with another company directly or indirectly, that is a reporting company or foreign traded; (2) does not borrow or issue debt obligations in connection with the fund's investment in such company and distribute to the venture capital fund the proceeds of such borrowing or issuance in exchange for the venture capital fund's investment; and (3) is not an investment company, a private fund, an issuer that would be an investment company but for the exemption provided by Rule 3a-7 under the Investment Company Act, or a commodity pool.

22 To meet the de minimis exemption, the commodity interest positions held by the private equity fund must (1) be established with aggregate initial margin, premiums and required minimum security deposit for retail forex transactions not exceeding 5 per cent of the portfolio's liquidation value or (2) have a net notional value not exceeding 100 per cent of the portfolio's liquidation value, in each case, after taking into account unrealised profits and unrealised losses on any such positions the private equity fund has entered into.

23 'Qualified eligible persons' includes, among other categories of investors, qualified purchasers.