On March 17th, Governor Ducey signed SB 1005 into law enabling greater availability of venture capital and other private equity in Arizona. Private equity and venture capital provide crucial sources of financing for businesses in Arizona, fueling economic growth, increasing the tax base and producing the needed jobs for our growing state. For many years now, the absence of significant venture capital and private equity in Arizona has frustrated the local business community and persisted despite various efforts by political leaders, industry groups and other stakeholders.
The newly signed law did not involve any expenditure of state funds or allocation of tax credits. Rather, it simply removed an outdated regulatory barrier that has generally made it prohibitively burdensome for venture capital funds and many other private equity funds to be located in Arizona. The applicable regulatory regime is complex and not well understood by many within the state. In very simple terms, Arizona’s regulatory regime subjected the managers of venture capital funds and various other private equity funds to the same licensing requirements applicable to the stockbrokers who buy and sell stock for clients on public exchanges like the New York Stock Exchange. For example, to obtain the requisite licensing to operate in Arizona, the manager of a venture capital fund was required to pass a broad-ranging written examination requirement (i.e. the Series 65 exam or the Series 66 and Series 6 exams), complete a written application, provide financial reports, be fingerprinted and pay annual licensing fees. Other states with thriving venture capital industries, even ones generally considered to have burdensome regulatory environments like California and Massachusetts, have long maintained licensing exemptions for venture capital and private equity funds. Fund managers already face daunting challenges to succeed even without a licensing requirement, such as an exhausting process of raising capital from financial institutions, pension funds and wealthy family offices, as well as the intense and risk-filled efforts associated with finding, making and growing a fund’s investments in promising companies to realize profitable returns.
States that have not adopted an applicable licensing exemption, which until now has included Arizona, essentially offer a large “KEEP OUT” sign directed at venture capital and private equity funds. In Arizona, this has not only deterred a number of venture capital funds (from California and elsewhere) from establishing formal offices here in Arizona, but has also restricted the formation of local funds here in Arizona.
By enacting SB 1005, Arizona takes a major step forward to update and modernize the Arizona Investment Management Act, which had not previously been updated for more than 14 years, to be more reflective of the regulatory approach applied to venture capital and private equity by many other states. SB 1005 is largely based on a model rule adopted by the North American Securities Administrators Association (NASAA), but also incorporates a number of improvements adopted by California and other states. Like the NASAA model rule, SB 1005 excludes bad actors (those involved in fraud) and does not exempt any funds from the application of traditional securities laws (concerning fraud, disclosure requirements, investor eligibility requirements, etc.) when raising money for their funds. However, SB 1005 also includes a special feature not found in the NASAA model rule, allowing the investors in certain funds with a small number of sophisticated investors to annually opt out of a potentially costly requirement to engage an outside auditor that might otherwise apply.
To be clear, the enactment of SB 1005 will not itself cause venture capital or private equity funds to form in or come to Arizona. However, it constitutes a critical enabler by removing an impediment that we know has previously prevented various venture capital funds from coming to Arizona, and other potential local funds from forming here. This type of legislative action does not generally make headlines, but reflects the type of common-sense governance our state needs. Our legislature, SB 1005’s sponsor (Sen. David Farnsworth) and the Governor should be commended for taking this important step forward.