fundraising special - BVCA admin

Comment
New fund,
new challenges
The heavier regulatory burden on financial services means new managers of start up and spin
out funds are facing an increasingly complex regulatory landscape, writes Bryony Livingstone,
a member at Kinetic Partners.
In the early stages of establishing a new group, the key concerns
centre around structuring the fund, building the investment
team and determining whether or not the fund is likely to attract
enough investors to get off the ground. There are now a number
of challenges facing new managers which mean that regulatory
issues need to be considered even earlier on in the process than was
previously the case.
One of the practical challenges facing new managers is that the
lead time to become authorised by the Financial Services Authority
(FSA) has increased considerably in the last two years. The statutory
timescales for processing applications have not changed and remain
up to a year (for incomplete applications). Previously the FSA worked
to and often exceeded its voluntary service standards of processing
75% of new managers’ complete applications within three months
of receipt. However, this is no longer the case and to reduce the
possibility of delays to first close (by when managers would need
to be regulated), applications for regulation need to be submitted
much earlier in the process.
Together with the longer approval process, the regulator is adopting
a more forensic approach to its scrutiny of new applications. Case
officers dealing with applications request detailed information
and will require drafts of legal documentation so that some of the
decisions and drafting that a new manager could often in the past
delay to nearer to close now have to be carried out much earlier in
the fundraising process. Consequently lawyers’ and other advisors’
fees are likewise incurred earlier on when there is less certainty that
the business will succeed.
The FSA’s prudential requirements require firms to provide at least
12 months’ month-by-month P&L, cash flow and proof of adequate
capital, amongst other things. The amount of capital required will
be dependent upon cash burn and start up costs as well as the FSA’s
‘headline’ financial resources requirement which tends to be low
for most venture capital managers. The FSA stress tests financial
projections, for example to determine whether a fund can cope with
several months’ delay to closing.
There is a range of non-prudential regulatory requirements that new
managers need to consider, including requirements for adequate
systems and controls to be in place on authorisation, establishment
of effective governance, conflicts policies, and compliance with
five key threshold conditions. From the financial crime perspective,
rigorous anti-money laundering controls are required including
detailed processes for KYC/source of funds identification for
investors and KYC/due diligence processes for potential investments
of the fund. The new bribery provisions are an additional area of
compliance that will attract greater regulatory focus in 2011.
The unprecedented regulatory burden does not stop with the UK’s
regime. In the US the Dodd-Frank Reform Act raises more regulatory
considerations which will require some managers to also become
registered with the SEC from 21 July, 2011 and for others to provide
information to the SEC as “Exempt Reporting Advisers”. Those
requiring dual regulation will need to submit applications to the SEC
as well as to the FSA and to comply with both sets of regulations.
Although the regime has not yet been finalised, the SEC has
proposed that Exempt Reporting Advisers will include “Venture
Capital” managers (narrowly defined), and a further category
entitled “Private Fund Advisers”. The proposal is that these Exempt
Reporting Advisers will be required to submit reports including
detailed information about both the manager and the funds to the
SEC, and that this information will be publicly disclosed. The SEC
would have access to the books and records of Exempt Reporting
Advisers as the proposals are currently drafted. The only managers
who would not be subject to either SEC reporting or registration
would be those who: have no place of business in the US; manage
less than US$25m of investments from US investors; have fewer
than 15 US investors; and do not hold themselves out generally to
the public in the US as an asset manager.
At the European level the AIFM Directive is due to be implemented
by member states within two years and will affect the way managers
and their funds are structured. The wide ranging provisions of the
Directive add yet another layer of requirements and disclosures to
be considered by start-ups and spin out managers. New managers
need to plan ahead and structure funds to take account of the
provisions of the Directive on their business.
New managers are increasingly required to satisfy many and
complex regulatory conditions early on in their formation process.
Long lead times for FSA authorisation in the UK mean that forward
planning and early decisions are required, whilst European and US
driven regulations add to the burden. It is important, especially for
first time managers, to tackle these regulatory challenges early on
in the process, and if necessary, to seek specialist advice to ensure
compliance at each stage of the authorization process, across all
relevant jurisdictions.
January 2011 BVCA Briefing 7