Strengthening of European venture capital funds – proposal for regulation amendment
On July 14 2016 the European Commission proposed to amend the Regulation on European venture capital funds (EuVECA-Regulation) to strengthen the European venture capital market. The proposal is part of a catalogue of measures aiming at the establishment of the Capital Markets Union and is intended to simplify cross-border marketing of European venture capital funds (EuVECA-Funds).
EuVECA-Funds are collective investment undertakings, also known as alternative investment funds, mainly investing in small and medium-sized enterprises (SMEs). These fund structures were implemented with the EuVECA-Regulation to ease the strict regulations for funds and fund managers. In Germany, instead of a cost-intensive authorization procedure pursuant to the German Capital Investment Act (Kapitalanlagegesetzbuch, KAGB), EuVECA-Funds can be established by a simple registration with the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht, BaFin). Upon a successful registration, fund managers are granted an EU-passport in order to market their EuVECA-Funds to approved investors throughout the EU without being subject to multiple registration procedures in each EU Member State.
What are the advantages?
EuVECA-Funds may be marketed to non-professional investors provided that the respective investment equals at least EUR 100,000 and the investor declares in writing that he is aware of the risk of such investment. Thus, EuVECA-Funds are able to reach a far broader investor base than funds which are subject to the KAGB. The latter face a strict regulatory environment, which allows fund marketing only to professional investors and semi-professional investors with high requirements for the qualification as a semi-professional investor.
Supervisory provisions for EuVECA-Funds are considerably simpler compared to regulations under the KAGB, e.g. EuVECA-Funds are not obliged to publish a prospectus and no depositary is required. Furthermore, the EuVECA-Regulation does neither impose requirements on a minimum capitalization for fund managers, nor set out rules for the valuation of assets.
Which funds benefit from the EuVECA-Regulation?
Under the present legal regime, the EuVECA-Regulation is applicable to managers of funds with a value of managed assets below EUR 500 million. The determination of this threshold is based on the book value.
Additionally, EuVECA-Funds are obliged to invest a minimum of 70% of the aggregate capital contributions in assets that are qualifying investments, currently requiring compliance with the following criteria:
Eligible portfolio companies must be SMEs and therefore must not be listed on a regulated market, have less than 250 employees and either the annual sales must not exceed EUR 50 million or the annual balance sheet total must not exceed EUR 43 million. Qualifying investments are direct equity investments (including convertible instruments such as convertible bonds), supplementary investments such as loans – limited to 30% of the aggregate capital contributions – and acquisitions of shares from existing shareholders of a portfolio company (secondary).
Proposed amendments of the EuVECA-Regulation
The proposal by the European Commission to amend the EuVECA-Regulation includes three major adjustments regarding the current restrictions to qualifying investments and the registration of funds:
First of all, the European Commission proposes to expand the scope of the EuVECA-Regulation by cancelling the threshold of EUR 500 million and allowing fund managers, that under current laws are only subject to KAGB, to establish EuVECA-Funds and extend the scope of their target market.
Secondly, the limitations regarding portfolio companies are eased by including companies that have less than 500 employees, therefore doubling the current limit of 250 employees. The proposed amendments also provide for investments in portfolio companies listed on SME growth markets (e.g. Entry Standard Deutsche Börse, Alternative Investment Market London SE, NewConnect Warsaw SE, mid market Wiener Börse, First North Nasdaq OMX Nordic). In addition to that, the requirements to qualify as an eligible portfolio company have to be fulfilled only at the time of the EuVECA-Fund first investment.
Thirdly, the European Commission intends to simplify the registration process and reduce the costs for such registration. In particular, a successful registration under the EuVECA-Regulation will render a second registration under the Alternative Investment Fund Managers Directive (AIFMD) obsolete. The proposal includes a determination for the minimum capital requirement to harmonize current differences between EU Member States regarding the amount of own funds required to register an EuVECA-Fund. Furthermore, competent authorities of the EU Member States are obliged to decide on the application for registration of a fund within two months and registration costs will be decreased as the proposal explicitly prohibits fees currently imposed by such authorities for marketing funds in their respective jurisdiction.
Impact on professional practice
Fund managers authorized under the KAGB will be entitled to establish EuVECA-Funds and benefit from marketing those funds to the extended investor base including non-professional investors throughout the EU, while only being subject to the less strict provisions of the EuVECA-Regulation. Correspondingly, the list of eligible qualifying companies will be extended, enabling EuVECA-Funds to invest in small mid-cap companies. The list-ing on a SME growth market will no longer be an obstacle for investments from EuVECA-Funds. Since the thresholds will only apply for the first initial investment, a long-term funding will be possible. Therefore, the EuVECA-Fund is entitled to further invest in a start-up which has exceeded the thresholds for workforce and annual sales due to enormous growth.
Such amendments allow for more companies to benefit from EuVECA-Fund investments and provide investors with a larger scope of potential portfolio companies. The explicit prohibition of fees will ensure that cross-border management and marketing of funds throughout the EU with the EU-passport is not restricted by competent authorities of the EU Member States imposing fees for commencing business or annual fees for fund marketing in their respective jurisdiction.
The proposal of the European Commission was submitted to the European Parliament and the Council for co-decision in the course of ordinary legislative procedure. We will keep you informed on further developments.
Any questions? Please contact: So-Ang Park and Georg Schneider
Practice Group: Private Equity & Venture Capital