How European venture capital funds can facilitate capital raising in the EU

The EuVECA regime established a set of product rules that apply to venture capital funds (EuVECA funds) and a prudential regulatory framework that applies to EU managers of those funds (EuVECA managers).

The main benefit of the EuVECA Regulation is the access it provides EuVECA managers to a pan-European marketing passport within a regulatory framework that is not as prescriptive as the Alternative Investment Fund Managers (AIFM) Directive.

In developing a regime for venture capital funds and their managers, the European Commission sought to establish an effective framework to eliminate cross-border barriers to competition in Europe for asset managers focusing on providing capital to small undertakings in the early stages of their development. It also designed to provide for the protection of investors.

Key Features of the EuVECA Regulations

Key features of the EuVECA Regulation are the following:

• EuVECA funds are restricted to investing in ‘qualifying investments’.
• EuVECA funds may be marketed to professional investors, investors who are treated as professional clients, or investors that commit a minimum investment of €100,000.
• EuVECA funds may be managed by a registered AIFM, sometimes referred to as a ‘small AIFM’, or an AIFM that is authorised under the AIFM Directive. 
• EuVECA managers are subject to a minimum initial capital requirement of €50,000 and an own funds requirement of at least one quarter of fixed overheads. Managers are required to comply with a prudential regulatory framework that sets out requirements such as conduct of business rules, management of conflict of interest, and resourcing requirements to name a few.

What is a qualifying venture capital fund?

An EuVECA fund means a collective investment undertaking, which is classified as an alternative investment fund under the AIFM Directive that invests at least 70% of its aggregate capital contributions and uncalled committed capital in assets that are ‘qualifying investments’, calculated on the basis of amounts investible after deduction of all relevant costs and holdings in cash and cash equivalents, within a time frame laid down in the constitutional document of the EuVECA fund.

An EuVECA fund may be either externally or internally managed, depending on its legal structure.

What are qualifying investments?

Under the EuVECA Regulations, 'qualifying investments' mean any of the following instruments:

• Equity or quasi-equity instruments that are issued by a qualifying portfolio undertaking and acquired directly by the qualifying venture capital fund from the qualifying portfolio undertaking; a qualifying portfolio undertaking in exchange for an equity security issued by the qualifying portfolio undertaking, or; an undertaking of which the qualifying portfolio undertaking is a majority-owned subsidiary and which is acquired by the qualifying venture capital fund in exchange for an equity instrument issued by the qualifying portfolio undertaking.
• Secured or unsecured loans, such as bridge financing, granted by the qualifying venture capital fund to a qualifying portfolio undertaking in which the qualifying venture capital fund already holds qualifying investments, provided that no more than 30% of the aggregate capital contributions and uncalled committed capital in the qualifying venture capital fund is used for such loans.
• Shares of a qualifying portfolio undertaking acquired from existing shareholders of that undertaking.
• Units or shares of one or several other qualifying venture capital funds, provided that those qualifying venture capital funds have not themselves invested more than 10% of their aggregate capital contributions and uncalled committed capital in qualifying venture capital funds.

  What are qualifying portfolio undertakings?

  A ‘qualifying portfolio undertaking’, at the time of the first investment by the EuVECA fund, complies with one of the following conditions:

  • it is not admitted to trading on a regulated market or on a multilateral trading facility and employs up to 499 persons.
  •  it is classified as a small and medium-sized enterprise (SME), which is listed on an SME growth market under Directive 2014/65/EU of the European Parliament and the Council.
  • is not an alternative investment fund under the AIFM Directive.
  • is not a credit institution, an investment firm, an insurance undertaking, a financial holding company or a mixed activity holding company; and
  • is established in a member state, or third country that is not listed as a non-cooperative country and territory by the Financial Action Task Force on anti-money laundering and terrorist financing, and has signed an agreement with the home member state of the EuVECA manager and with the member states in which the units or shares of the EuVECA fund are intended to be marketed to ensure that the third country complies with the standards laid down in Article 26 of the OECD model tax convention on income and on capital, and ensures an exchange of information on tax matters.

  Leverage and borrowing

  Under the EuVECA Regulation, managers are prohibited from increasing the exposure of an EuVECA fund beyond the amount of its committed capital, whether through borrowing of through the use of derivative instruments.

  An EuVECA fund may only borrow, issue debt obligations or provide guarantees where such borrowings, debt obligations or guarantees are covered by the fund’s uncalled commitments.

  Eligible investors

  To ensure that EuVECA funds are distributed only to investors that have experience and knowledge to make their own investment decisions.

  Marketing is restricted to investors who are professional investors, or persons who can be treated as professional investors. Other investors, including high net worth individuals, that commit to investing a minimum €100,000, and who state in writing that they are aware of the risks associated with the proposed investment.

  For such investors, safeguards should be established to ensure that the EuVECA fund is only marketed to investors that have the appropriate profile to make sure an investment or executives, directors or employees involved in the management of an EuVECA manager when investing in the EuVECA fund that they manage, on the basis that such individuals are knowledgeable enough to participate in venture capital investments.

  Application

  The EuVECA Regulation is voluntary, meaning that a manager may decide to opt in to the regulation, but is not obliged to do so. The “EuVECA” label may only be used by a fund where the manager has opted-in and received clearance to act as an EuVECA manager.

  The EuVECA Regulation applies to managers that apply for registration as an EuVECA manager, and whose assets under management do not exceed for €100 million for open-ended funds, or €500 million for funds that are closed-ended for a period of at least 5 years and whose portfolios are not leveraged.

  A fully authorised AIFM may opt into the EuVECA Regulation, and in that case most of the provisions of EuVECA Regulation, in addition to the AIFMD regulations, will apply to the authorised AIFM.

  Capital and own funds requirement

  An EuVECA manager is subject to the minimum capital and own funds requirements. This includes a minimum initial capital requirement of €50,000. An EuVECA manager is required all times to maintain own funds of at least one quarter of the firm’s fixed overheads incurred in the preceding year.

  An EuVECA manager is also required to provide an additional amount of own funds equal to 0.02% of the amount by which the total value of the EuVECA funds exceeds €250 million. On application to the Central Bank, up to 50% of this additional amount of own funds may be satisfied if the EuVECA manager benefits from a guarantee for the same amount given by a specified credit institution or an insurance undertaking.

  Process for Registration as an EuVECA Manager

  In Ireland a firm is required to apply to the Central Bank of Ireland for registration if it intends to act as an EuVECA manager. The firm should provide specific information in support of its application such as the identity of the persons who conduct the business of the EuVECA manager, the identity of the EuVECA funds and their strategies to be marketed in the EU.

  Additional information on the arrangements for complying with the requirements of the EuVECA Regulation should also be provided, such as the submission of a programme of operations which describes how the EuVECA manager will adhere to the requirements of the EuVECA Regulation and a list of EU Member States where the EuVECA manager intends to market each EuVECA fund.

  The EuVECA manager is required to put in place a programme of operations, which addresses the following requirements:

• Conduct of Business: Details of policies and procedures for preventing malpractices that would affect the interests of investors.
• Delegation: Details of any functions delegated to third parties and the identity of such delegates.
• Conflict of interest: Details of organisational and administrative arrangements in place to comply with the proper management of conflict of interests.
• Resources: Details of the EuVECA manager’s human and technical resources and how these resources are sufficient to carry out the proposed activity, confirmation that the EuVECA manager will at all times ensure that it is able to justify the sufficiency of its own funds to maintain operational continuity, and confirmation that the EuVECA manager will at least retain, for the purposes of providing for an orderly wind-down, one quarter of its preceding year’s fixed overheads.

   

• Staffing details: Details of the directors and senior persons within the EuVECA manager and their respective roles, relevant divisions and the reporting lines, evidence that the individuals effectively conducting the business of the EuVECA manager possess adequate knowledge and understanding of the qualifying portfolio undertakings in which the EuVECA funds propose to invest, and prior regulatory clearance of persons that will perform pre-approval control functions within an EuVECA manager.

  The Central Bank will only register an EuVECA manager, where it has received and is satisfied with the above information and that the arrangements for complying with the requirements of EuVECA Regulation are appropriate. The Central Bank must also be satisfied that persons who conduct the business of the EuVECA manager are of sufficiently good repute and are sufficiently experienced.

  An applicant for registration as an EuVECA manager is required to be informed no later than two months after it has submitted a complete application to the Central Bank, (or where relevant to the competent authority of its home member state), whether its application has been successful.

  Ongwwoing regulatory requirements

  EuVECA managers are required to act honestly, fairly and with due skill, care and diligence in conducting their activities. They must also conduct their business activities in such a way as to promote the best interests of the funds they manage, investors and the integrity of the market.

  A high level of diligence must be applied in the selection and ongoing monitoring of investments and the manager must possess adequate knowledge and understanding of the undertakings in which they invest.

  EuVECA managers are also required to treat investors fairly and ensure that no investor obtains preferential treatment, unless such preferential treatment is disclosed in the rules or instruments of incorporation of the EuVECa fund.  They must identify and avoid conflicts of interest, and where conflicts cannot be avoided, manage, monitor and promptly disclose conflicts of interest to investors in order to prevent such conflicts adversely affecting the interests of investors.

  Furter, at all times, managers must have sufficient own funds and use adequate and appropriate human and technical resources as necessary for the proper management of the EuVECA fund, make an annual report of each EuVECa fund available to the regulator of the EuVECA manager’s home member state within six months following the end of the financial year, and notify its home member state regulator of any material changes to the conditions for its initial registration before such changes are implemented.

  Delegation by EuVECA managers

  An EuVECA manager may delegate functions to third parties provided its liability towards the EuVECA fund and its investors remains unaffected. An EuVECA manager may not delegate functions to the extent that it becomes a letter-box entity.

  Cross-border management

  An EuVECA manager that is established as a registered AIFM, which is the usual practice, is not permitted to manage funds on a cross-border basis. An authorised AIFM may manage an EuVECA fund on cross-border basis, subject to compliance with the EuVECA product rules.

  Benefits of the EuVECA designation

  The EuVECA label grants significant practical advantages that are not accessible to other AIFs or their managers, which include the following:

• There is no requirement for an EuVECA Fund to appoint a depositary, which may be a significant cost saving for investors.
• EuVECA funds may be distributed in the EU using a marketing passport to professional investors or to other investors, not professional investors, who commit to a minimum investment of €100,000.
• An EuVECA manager may be established as a registered AIFM, which is a lighter-touch regulatory regime and is much less prescriptive than the provisions of AIFMD applicable to an authorised AIFM.
• An EuVECA manager may engage in marketing activities once the marketing application has been submitted to the home member state regulator, whereas an AIFMD marketing application may require a 20-business day waiting period.

Despite the benefits that the EuVECA regime offers, the take-up by venture capital managers of this product has been relatively low. This may partially be explained by the restricted scope of investments that an EuVECA fund may acquire. However, it appears that the opportunities presented by the EuVECA regime have to date been largely overlooked by venture capital managers.