Helen Parsonage, Partner and Rachael Clayden, Senior Assoicate at international legal practice Osborne Clarke LLP, outline the key features of the EuVECA Regulation, how fund managers can go about becoming a EuVECA fund manager, and what Brexit will mean for the EuVECA regime.
The European Venture Capital Funds Regulation (EU 2013/345) (the “Regulation”) was adopted in 2013 with the aim of making it easier for venture capital managers to raise funds across Europe by creating a pan-European marketing passport for managers registered under the EuVECA designation.
Under the Alternative Investment Fund Managers Directive (2011/61/EU) (“AIFMD”), only full-scope AIFMs can use a marketing passport to market their funds across the EU. Given that many venture capital managers are sub-threshold AIFMs, this could have put them at a disadvantage and would have meant that in order to market across the EU, a venture capital manager would have had to comply with the national private placement rules (“NPPR”) in each jurisdiction into which its funds were marketed. In addition, the AIFMD and NPPR regimes generally exclude marketing to high-net-worth individuals, often a significant target market for venture funds. The Regulation was therefore introduced to plug that gap, and ensure that venture capital managers could more easily market their funds across the EU.
The Regulation was recently amended, with the amendments coming into force on 1 March 2018. The changes were intended to encourage a greater uptake in the use of EuVECA funds.
What is an EuVECA fund?
The Regulation covers a sub-category of EU-based alternative investment funds that focus on start-ups and early stage companies. Private investment via funds with this focus is a key element in the growth of these types of enterprises.
For a fund to qualify as a EuVECA fund, it must:
(a) meet the definition of an alternative investment fund;
(b) intend to invest at least 70% of its aggregate capital contributions and uncalled committed capital in assets that are “qualifying investments”;
(c) not use more than 30% of its aggregate capital contributions and uncalled committed capital to acquire non-qualifying investments; and
(d) be established in the EU (both the fund and the manager).
“Qualifying investments” are: i) equity or quasi-equity instruments either issued by the portfolio company or acquired in a secondary transaction; ii) secured or unsecured loans granted to a portfolio company (subject to a 30% cap on commitments being used for this purpose); or iii) units or shares in other EuVECA funds provided that they don’t in turn invest more than 10% in other funds. In each case, the relevant portfolio company must be a “qualifying portfolio undertaking”, meaning it must be:
(i) not admitted to trading on a regulated market or multilateral trading facility (MTF) and employ up to 499 persons; or
(ii) a small or medium-sized enterprise, which is listed on an SME growth market;
(b) not a collective investment undertaking, a credit institution, an investment firm or an insurer; and
(c) established in the EU or another country, provided such other country:
(i) is not listed as a non-cooperative territory by the Financial Action Task Force on Ant-Money Laundering and Terrorist Financing; and
(ii) has a cooperation arrangement in place with the member state of the manager of the fund. This type of cooperative agreement would be to ensure an effective interchange of tax information between the two countries.
Registration as a EuVECA manager is only available to managers that are established in the EU and registered by their home state regulator.
EuVECA marketing passport
Registering as a EuVECA manager allows firms to market qualifying funds throughout the EU to certain categories of investors under the EuVECA ‘label’, namely:
(a) MiFID professional clients;
(b) high-net-worth individuals, if they commit a minimum of €100,000 and state in writing that they are aware of the risks associated with the investment; and
(c) executives, directors and employees involved in the management of the funds.
Applying to be an EuVECA manager
In order to become registered as a EuVECA manager in the UK, a fund manager can either be authorised as an AIFM (with a EuVECA manager designation as an add-odd) or simply registered as a EuVECA manager under the alternative regime for small registered UK AIFMs. The form that must be completed is available from the FCA’s website. A firm will require a regulatory business plan, and the persons that “effectively direct the business of the EuVECA fund” must complete a senior persons form. When applying to become EuVECA registered, the manager must have at least one EuVECA-compliant fund that it is either going to commence managing, or that it is in the process of raising.
Managers applying to be registered as a EuVECA manager should note that, since 1 March 2018, there is also an “own-funds requirement” attaching to such a designation. A EuVECA manager is required to have minimum initial capital of €50,000, plus own funds which at all times amount to at least one-eighth of the fixed overheads incurred by the manager in the preceding year. Where the value of the EuVECA funds managed by the manager exceeds €250 million, the manager must have 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.
An alternative to registering as a EuVECA manager is for the fund sponsor to work with a third party AIFM which already has this designation, such as Sturgeon Ventures. This removes some of the administration involved for smaller, first time venture capital managers.
To date, uptake of the EuVECA regime has been significantly higher in the UK than elsewhere in the EU. And no article about an EU regulation would be complete without considering the possible effects of Brexit.
First, the good news. The departure of the UK from the EU should not have an effect on the investments made in UK companies by European EuVECA funds. On 22 November 2017, the UK Parliament’s Select Committee on European Scrutiny reported on the implications of Brexit for the use of the EuVECA Regulation by UK-based firms. The committee noted that “qualifying investments” must either be in an EU country (which will no longer apply to the UK) or in countries which have a cooperation arrangement with the fund’s home member state (and each EU country where the fund is marketed). In response to a request for clarification, HM Treasury confirmed on 30 December 2017 that where the UK is treated as a third country, EU-based EuVECA funds can still invest in UK start-ups as they would still be classified as qualifying investments, given that:
(a) the UK is not listed as a non-cooperative country by FATF; and
(b) the UK already has multi-lateral agreements in place with all EU member states covering the exchange of information. The UK and all EU member states are signatories to the Convention on Mutual Administrative Assistance in Tax Matters (there are more than 100 signatories). This means that the UK already meets the OECD standards for exchange of information for tax purposes and will continue to after withdrawal for the EU.
The bad news is that only funds which are established in, and which have managers established in, the EU can currently become EuVECA funds. Following the date of the UK’s departure from the EU (or the end of any agreed transition period, whichever is later), UK-based EuVECA funds will automatically lose their EuVECA status and UK-based EuVECA managers will lose their right to passport their funds across the EU.
UK-based managers may therefore want to start considering either establishing management entities in other EU jurisdictions, or exploring options in relation to the use of third party host-AIFMs in other member states.