Expanded scope of protected information

The definition of “customer information” under Regulation S-P is broadened to include any record containing nonpublic personal information about a customer of a covered institution. The definition includes “personally identifiable financial information” and more broadly encompasses “any list, description, or other grouping of consumers (and publicly available information pertaining to them) that is derived using” nonpublic personal information.

Regulation S-P applies to customer information regardless of whether the customer information relates to individuals with whom the covered institution itself has a relationship, arguably requiring notification to individuals if the covered institution is processing that information on behalf of another entity.

Incident response program

Covered institutions must implement a written incident response program in order to detect, respond to and recover from security incidents impacting customer information. At a minimum, the program must include written policies or procedures that help the covered institution to:

• Assess the nature and scope of an incident to determine whether there was any unauthorized access to or use of customer information.
• Contain and control the incident.
• Notify impacted individuals of the incident.

The incident response program should be commensurate to the covered institution’s size, operations and data processing activities.

Federal breach notification standard

The amendments establish a federal breach notification standard. Under Regulation
S-P, covered institutions must provide clear and conspicuous written notice to each affected individual whose sensitive customer information was – or is reasonably likely to have been – accessed or used without authorization. Regulation S-P defines sensitive customer information broadly as any customer information “the compromise of which could create a reasonably likely risk of substantial harm or inconvenience to an individual identified with the information,” unlike other data breach regulations, which define specific data elements that are considered to trigger notification obligations.

This notice must be provided as soon as practicable, but no later than 30 days after becoming aware of the incident, except under certain limited circumstances where the US attorney general determines that the notice poses a substantial risk to national security or public safety and notifies the SEC of such determination.

The notification to individuals must include:

• A description of the incident and the types of data involved.
• Recommended steps individuals can take to protect themselves (e.g., placing fraud alerts, obtaining credit reports).
• Resources from the Federal Trade Commission on protecting oneself from identity theft.
• More than one method for the customer to contact the covered institution.

One of the most notable provisions of Regulation S-P is the requirement to notify all individuals whose sensitive customer information resides on the covered institution’s system that was subject to unauthorized access, if the covered institution cannot determine which individuals’ sensitive information was subject to unauthorized access.

Notification is not required if the sensitive information was not subject to unauthorized access or use, or if the RIA determines after conducting a reasonable investigation that the sensitive customer information has not been and is not reasonably likely to be used in a way that would result in substantial harm or inconvenience to the customer.

Service provider oversight

Incident response programs must contain written policies and procedures that address due diligence and ongoing monitoring of service providers who have access to customer information.

These policies and procedures must require the service provider to:

• Take reasonable measures to protect against unauthorized access or use of customer information.
• Notify the RIA as soon as possible, and no later than 72 hours, after becoming aware of a breach involving customer information processed by the service provider.

RIAs may contract with service providers to send customer notices on their behalf, but the RIA remains ultimately responsible for ensuring timely and compliant notification.

Data disposal requirements

Under the amendments, covered institutions must have written policies and procedures addressing data disposal and take reasonable measures to securely dispose of customer information.

Recordkeeping requirements

Covered institutions must maintain written records documenting compliance with Regulation S-P. This includes:

• Policies and procedures implementing Regulation S-P’s requirements.
• Documentation of incidents and the covered institution’s incident response.
• Records of incident forensic investigations and the covered institution’s determinations regarding notification of individuals.
• Copies of any notices sent to individuals.
• Documentation related to service provider diligence and oversight.

These records must be retained for five years, with the first two years in an easily accessible format.

Annual privacy notice exception

The amendments codify the Gramm-Leach-Bliley Act (GLBA) exception to annual privacy notices. RIAs are exempt from delivering annual privacy notices if:

• They have not changed their data privacy and disclosure practices.
• They only share nonpublic personal information with nonaffiliates under an applicable exception.

What registered fund managers should do by December 3, 2025

For “large” registered fund managers, the practical implications are clear – and urgent. By the compliance deadline, managers should be prepared to:

• Demonstrate a fit-for-purpose incident response program.
• Implement breach notification workflows that meet the 30-day timeline and content requirements.
• Map and vet service providers and require service providers to notify covered institutions of data breaches within 72 hours.
• Apply expanded data disposal safeguards.
• Update recordkeeping practices.

Need help?

If you would like assistance operationalizing these requirements across policies, vendor oversight, templates and training, please reach out to your Cooley contact to be connected with our cyber/data/privacy practitioners.

Key insights from Alexa von Tobel

On investing in companies driving industry disruption: “We believe that venture capital – when properly deployed – is the most powerful economic engine that the world has ever seen. … Economic value truly arises when big risks are solved, and when companies create innovative products and business models – often those that couldn’t have existed previously.”

On the best way investors can add value to startups: “One of our main objectives as a team is to be our founders’ first call. We strive to build relationships with our founders that give them space to not only share their wins, but also be open about their stickiest problems.”

On key trends from this quarter’s VC data: “The recent pullback in later-stage valuations may reflect a recalibration of expectations following years of inflated valuations. We are seeing continued conviction in early-stage investing, with seed-stage valuations remaining unchanged, while investors are adopting a more cautious approach in later rounds where the risks of overvaluation are more pronounced.”

Read full commentary from Alexa von Tobel

Key Insights from Julie Yoo

On predictions about the healthtech industry: “Software is (finally!) absolutely eating the healthcare world. In fact, the nature of the major challenges that the healthcare industry has faced in the last couple of years … are so conducive to software-based transformation that we have more conviction than ever on our core thesis.”

On why we are seeing a downward trend in investments in technology and life sciences companies: “Many growth-stage companies raised large enough amounts of minimally dilutive capital in 2021 and early 2022 that they had enough runway to live through this window without having to raise.”

On why deal terms remained stable while invested dollars, deal volume and up rounds are on the decline: “Early-stage deals tend to have less deal term structure, so we’re most likely seeing cleaner terms since most of the deals that got done in Q1 were in the earlier-stage zone.”

Read full commentary from Julie Yoo

Key insights from Kate McAndrew

On recent trends in early-stage financings: “[T]he fundamentals of investing and company building are coming back. For the most part, pre-seed rounds have reset to be in the $750,000 to $2.5 million range and priced in the $5 million to $12 million post-money range.

On growing a startup in the current economic climate: “[L]ean times make for lean teams – and that is an asset in the first years after company formation. It forces founders to determine who and what is essential. It makes for a focused, customer-obsessed culture. Those values will help you grow, scale and endure.”

On building relationships with founders and mentoring companies: “A big part of this work is personal. I try to get to know founders as whole people, not just CEOs or CTOs, and to build a real relationship with them. … And then, honesty is vital. … Ultimately, you need to be able to tell founders hard truths and be very honest about what is working and what is not.”

Read full commentary from Kate McAndrew

Key insights from Matt Sacks

On the future of the Midwest’s innovation ecosystem: “Over the past decade, the size of the venture capital industry has expanded at a remarkable pace. … We believe there is a tremendous opportunity to be a capital provider to the early-stage innovation ecosystem in the Midwest and help this market develop.”

On disruptive technology trends in the Midwest: “[W]e find that the Midwest ecosystem generates a significant number of exciting startups attempting to disrupt categories like steel manufacturing and commodities trading.”

On the growth of Chicago’s VC market: “To truly achieve scale, a startup ecosystem needs to nurture an appetite for risk and acceptance of failure, have great research institutions and strong engineering talent pools, have a series of successful prior-generation companies that created significant value for those involved, and importantly, have enough early-stage capital providers willing to embrace risk.”

Read full commentary from Matt Sacks

Key Insights

On various sub-segments in Web3: “There are commonalities within the sub-segments due to a shared ethos around concepts like decentralization and uncensorability. But the various sub-segments are fundamentally tackling different problems.”

On disrupting traditional industries: “[E]very participant in every creative industry is looking at Web3 and asking the question: ‘What does this mean for me?’”

On Web3 changing the investment landscape: “A fundamental principle that’s been adopted by Web3 builders is that value should accrue to the community that adds value to an ecosystem rather than to a small number of investors and builders in the ecosystem.”

Read full commentary from Frank Rotman

Key Insights

On valuations and later-stage investments: “As a growth investor, I believe the valuation environment puts a bigger onus on us to make the right calls on investments. … We have to make sure we are picking winners who will grow into and beyond their valuations.”

On the Bain Capital Ventures platform: “Everyone on the Bain Capital Ventures team is laser-focused on one or two sectors. … Because we spend a lot of time in our areas, we like to think we can disproportionately support and contribute to the success of our portfolio companies.”

On embedded marketplaces: “We believe that the future of vertical SaaS will be defined by embedded financial services and embedded marketplaces. … We are seeing embedded marketplaces pop up everywhere – in software for construction, spas and salons, restaurants, financial institutions … the list goes on.”

Read full commentary from Merritt Hummer

Key insights

On the pace of the market: “The use of technology has been paramount for companies, organizations and institutions to operate through an unparalleled period. This has led to increased purchasing, growing company revenues, and further capital allocation and investment at record levels.”

On founding BLCK VC: “[A]s current Black venture capitalists, we could see the reliance on personal networks for access to roles at firms, but also the reliance of these networks to drive deal flow, were creating structural barriers for the Black community.”

On upside and impact: “The current system, as it is, is leaving huge economic upside on the table largely because networks haven’t evolved. The reality is that companies that prove successful are global – and to be global, you need to be diverse.”

Read full commentary from Frederik Groce

Key Insights

On going back to basics this year: “HMI made its first investment in early 2009. … Everything was for sale, and the experience taught us some important lessons – prioritize the best ideas and then invest in those with conviction, focus on high-quality businesses that can compound through cycles, and think about investing outcomes as probabilistic rather than single pathways.”

On a robust deal environment: “Q4 was the most active quarter we have seen in years. We believe the fourth quarter generally had more deal flow than usual due to political uncertainty and high valuations, coupled with lots of capital, making for a good supply-demand setup.”

On putting money to work right now: “We’ve been selective, focusing on great companies that can grow for a decade or more. The base rate for decade+ compounders is not amazing, but if you can find them, your entry valuation doesn’t matter so much. If you’re wrong, it’s a different story.” 

Read Full Commentary from Sean Barrett

GGV Capital VIII will support entrepreneurs across all stages of growth; GGV Capital VIII Plus enables GGV to extend its investment in portfolio companies that are part of Fund VIII that have demonstrated ability to scale and have become category leaders; GGV Discovery III is dedicated to global entrepreneurs at the earliest stage of development; and GGV Capital VIII Entrepreneurs Fund will continue to the firm’s tradition of extending and building the GGV entrepreneur family network globally.

The closing of the funds coincides with one subsequent closing of GGV Capital RMB Fund II, with total committed capital of approximately $525 million. This increases the firm’s total capital under management to approximately $9.2 billion across 17 funds.

“It’s been another productive, highly efficient experience working with Jordan and his team at Cooley once again to raise our biggest funds in history in less than three months,” said Jenny Lee, managing partner at GGV. “We are excited as this capital will allow GGV to continue to invest in entrepreneurs around the world across all stages of growth.”

GGV Capital has been a Cooley client since its founding in 2000. Cooley has advised GGV on the closing of all its USD-denominated funds and 80+ of its financing transactions across the US, China, Southeast Asia and India. GGV Capital invests in seed-to-growth stage companies across three sectors: social/internet, enterprise tech and smart tech. Over the past two decades, GGV has backed more than 400 companies around the world. In the past 15 months, 11 GGV portfolio companies have completed public listings, including Affirm, Agora, Airbnb, BigCommerce, DraftKings, eHang, Kingsoft WPS, Poshmark, Opendoor Technologies, Wish and Xpeng.

About Cooley LLP

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Key Insights

On valuations moving forward: “While the amount of capital in the system is so high, it’s discerning in nature, and some of these rounds that were done based on forward multiples last year are going to be hard to clear if growth expectations aren’t met or customer demand tapers off.”

On late-stage investing: “The 0.01% of these [very high-quality, fast-growing] companies are almost in the ‘I-can-name-the-price-I-want’ mode, and they’ll often get it in the private markets (within reason) if the growth and efficiency are there.”

On evaluating new investments during the pandemic: “The way we’ve gotten comfortable has honestly been scheduling time for unstructured conversations. … Having some dedicated social time makes a difference.”

Read Full Commentary from Logan Bartlett

We are providing updates on our original post here to reflect the issuance of a final rule by the U.S. Treasury Department which will become effective on October 15, 2020.  Between November 2018 (when the first regulations implementing FIRRMA came into effect) and October 15, 2020 (when the Final Rule becomes effective), mandatory CFIUS filings were assessed with reference to an industry test, which asked whether the U.S. business receiving an investment or being acquired utilizes its technology in, or designs its critical technology for use in, certain industries listed in the CFIUS regulations (e.g., biotechnology, battery manufacturing, semiconductor manufacturing, and so forth).

The final rule disposes of that industry criterion and replaces it with a new test that asks whether a U.S. regulatory authorization (e.g., an export license) would be required to release the U.S. business’s products or technology to its foreign investor or acquirer pursuant to any of the four main U.S. export control regimes administered by the Departments of State, Commerce, Energy and the Nuclear Regulatory Commission. More specifically, the final rule requires transacting parties to determine whether a regulatory authorization would be required for the “export, reexport, transfer (in-country) or retransfer” of the critical technology of the U.S. company to the specific foreign investor or acquirer and certain other foreign persons or entities in that foreign investor’s or acquirer’s upstream ownership chain.

Unlike the comparatively simple (though somewhat ambiguous) industry test, which focuses on the business activities of the U.S. company, the far more complex regulatory authorization test focuses on the export control classification of a U.S. business’s products and technologies, as well as the principal place of business (for entities) or nationality (for individuals) of each of the foreign parties involved, including certain entities in the foreign parties’ ownership chains.

Practically speaking, the final rule will add complexity to assessments of mandatory CFIUS filing requirements – particularly with respect to the requisite export control/regulatory authorization analysis, and determinations of whether an investor is a “foreign investor,” and if so, such investor’s specific nationality.

Under the CFIUS regulations in effect prior to October 15, 2020, the absence of a mandatory filing requirement often could be ascertained relatively easily (e.g., by determining that the U.S. business in question does not operate in one of 27 sensitive industries listed in the CFIUS regulations). Under the final rule, mandatory filing determinations require more comprehensive diligence of both the U.S. business and the foreign investor(s) or acquirer.  The U.S. business may need to assess not only the products that it sells, but also the technologies related to the development, production or use of those products, as well as any technologies that are developed and tested for the U.S. business’s internal use only.  Foreign investors and acquirers may need to determine their own nationality and the nationalities of all foreign persons and entities in their upstream ownership chains.

Venture funds investing in U.S. companies that may be implicated will require more complex and detailed legal guidance after October 15, 2020 than previously.  Care should be taken to add as a “checklist item”, early in the investment process, an analysis of the potential target company for CFIUS purposes.

Previous Blog Post (January 2, 2020)

Contributors

Jordan Silber

Unregistered “finders” have long been a fixture in the venture capital community, and a source of considerable regulatory uncertainty.  Based on SEC guidance dating back to the early 1990’s, a so-called “finder’s exemption” was thought to exist whereby a person could perform the limited function of introducing investors to an issuer, such as a venture capital firm raising a new fund, for compensation without registering with the SEC as a broker.  However, the SEC never formally endorsed a “finder’s exemption.”

Indeed, based on its broad interpretation of the term “broker,” the SEC has in some cases over the years denied regulatory relief to finders and even brought enforcement action against finders and the issuers that hired them.

As market practices and the SEC’s approach to finders have diverged, fund managers that want to use unregistered “finders”  have faced a difficult choice: accept the regulatory risk, insist that the “finder” associate herself with a licensed broker-dealer or simply forego the chance for increased investor introductions.  IA particular regulatory risk faced by fund issuers was resulting doubt regarding the use of Regulation D as a 1933 Act exemption for their offerings.

In response to demands from the industry over many years for additional clarity in this space, the SEC has now proposed a formal exemption from broker registration requirements for finders that meet certain conditions.  If the exemption is approved as proposed, it will provide much needed regulatory certainty for fund managers and a clear framework for how finders should be engaged.

Scope of the Proposed Exemption

The proposed exemption would permit payment of transaction-based compensation by fund managers (i.e., a percentage of sourced investors who subscribe to the fund, for example) to finders, provided the following conditions are met:

• The finder is a natural person, and not a legal entity or fundraising platform;
• The fund using the finder does not file reports with the SEC under the Exchange Act and is relying on an exemption from the Securities Act (such as Regulation D) to conduct a primary offering;
• The finder does not engage in general solicitation;
• All potential investors solicited and introduced by the finder are “accredited investors”;
• The issuer and finder enter into a written agreement that describes the finder’s services and compensation;
• The finder is not associated with a broker-dealer; and
• The finder is not subject to a statutory disqualification.

These conditions align well with primary offerings of private funds that rely on the 3(c)(1) or 3(c)(7) exemptions from registration under the Investment Company Act of 1940, and are offered under Rule 506(b) of Regulation D.  We suspect that our fund clients’ typical relationships with finders will generally be able to be conducted in a manner consistent with these conditions.

Tier I and Tier II Finders

The proposed exemption covers two categories of finders:

• Tier I finders would be permitted to provide contact information of potential investors in connection with a single capital raising transaction by the fund in a 12 month period, but would not be permitted to have any contact with a potential investor about the fund. This exemption essentially permits a finder to sell her rolodex to an issuer in exchange for success fees.

• Tier II finders would be permitted to engage in more direct solicitation activity, including identifying and screening potential investors; distributing offering materials to the prospective investors; discussing the offering with the prospective investors (but not advising as to the valuation or advisability of investing); and arranging or participating in meetings with the prospective investors and the issuer.

Because of their greater involvement in solicitation activities, Tier II finders would be required to provide a solicitation disclosure to each prospective investor prior to or at the time of the solicitation, and obtain a written acknowledgment of receipt of that disclosure from each prospect who invests in the fund. This process closely tracks the requirements that registered investment advisers are required to follow when hiring solicitors under the “Cash Solicitation Rule”, and we expect that finders and the fund managers that hire them will be able to leverage existing industry standard forms of agreements and disclosures to meet these requirements.

What Happens Next?

The proposed exemption will soon be published in the Federal Register, which will start a 30-day comment period. The SEC staff will then gather and review the comments, and determine whether any changes to the proposal should be made. During that process and until the exemption is ultimately finalized, we unfortunately remain in the murky grey area of uncertain regulatory risk. In addition, while some may view this proposal as an expression of the SEC’s views on the regulatory treatment of finders, we note that this proposal is not yet effective and caution is still warranted when dealing with unregistered finders.

Contributors

Kenneth Juster

The HSR Act requires parties to transactions that meet specified thresholds and do not fall within an exemption to report them to the antitrust agencies and observe a waiting period before consummating reported transactions. The HSR Act allows the agencies to investigate whether such proposed acquisitions are likely to lessen competition and to challenge them under antitrust law before they are consummated.

Read Full Article

Changes for Individual Investors

1.  Professional Certifications, Designations or Credentials

Traditionally, the sole avenue by which an individual investor could meet the accredited investor definition was through that investor’s relative wealth or income.[i]  However, through the Adopting Amendment, the SEC will now also look to the professional certifications, designations and/or credentials of an individual issued from an approved educational institution as evidence of one’s requisite financial sophistication and ability to assess the related risks of a securities offering to meet the accredited investor definition, regardless of an individual’s level of wealth or income.  The SEC has stated that, for now, the only recognized individuals eligible for accredited investor status under this new category are those individuals in good standing holding a Series 7, Series 65 and/or Series 82 license.  Notwithstanding this, the SEC has the ongoing authority to adjust and add to those professional certifications, designations and credentials they deem sufficient to confer accredited investor status on an individual, and thus, it is likely further types of credentialed and licensed professionals will be added in time by the SEC to the list of those individuals permitted to be treated as accredited investors under this new professional certification category.  For now, the movement away from a wealth and income-based analysis in this category is a good first step by the SEC to open the private offering markets to potential additional individuals.  However, it is still very early days with this new and expansive category to fully comprehend yet the potential implications for funds and their investors, especially with respect to the more complex fund private offerings such as those conducted under Rule 506(c) of Regulation D (i.e., general solicitation offerings) which require a much greater degree of independent verification of each investor’s accredited investor status.  Further, it remains to be seen whether this new professional certification method of qualifying for accredited investor status will be materially additive to the overall number of potential accredited investors eligible to participate in fund and other private offerings, given that many of such individuals may, by the very nature of their qualifications and profession, already meet the wealth or income requirements in the first instance.

2.  Knowledgeable Employees

As applicable solely to investments by individuals in private funds, the Adopting Amendment adds a new category of accredited investor for individuals who qualify as “knowledgeable employees” of the fund sponsor as defined in Rule 3c-5(a)(4) under the Investment Company Act of 1940, as amended (the “ICA”). Pursuant to the ICA, an individual that is a knowledgeable employee is allowed to invest in private funds sponsored by the fund manager employing such individual without affecting the fund’s ability to qualify for the exclusions from the definition of “investment company” under Section 3(c)(1) or Section 3(c)(7) of the ICA. Individuals meeting this category are deemed to possess the requisite information and financial sophistication regarding the particular fund offering due to their intimate involvement with the firm sponsoring such fund and its investment portfolio.  Individuals qualifying as knowledgeable employees include (a) executive officers, directors, trustees, general partners, advisory board members or persons serving in a similar capacity of a fund exempt from the ICA under Section 3(c)(1) or 3(c)(7), or affiliated persons of the fund who oversee the fund’s investments and (b) employees or affiliated persons of the fund (other than employees performing solely clerical, secretarial or administrative functions) who, in connection with the employees’ regular functions or duties, have participated in the investment activities of such private fund (or other private funds) for at least 12 months.  Thus, the key take away here is that, while the underlying analysis is a fact specific one, it is likely that only mid to senior level personnel with heavy involvement in and responsibility for the investment activities of the firm will be eligible for accredited investor treatment under this new category.

3.  Spousal Equivalent

The Adopting Amendment broadened the scope of the existing income and net worth tests applicable to individuals by not only permitting the income and/or net worth of a spouse of the individual to be considered when determining the individual’s status as an accredited investor[ii] but also the income and/or net worth of that individual’s “spousal equivalent” (in lieu of the individual’s spouse).  A spousal equivalent is generally considered to be a cohabitant occupying a relationship with the individual equivalent to that of a spouse without the requirement for a formal official recognition of such status (e.g., a domestic partnership or civil union).  While this specific change will not likely result in a material influx of new qualifying investors, it does reflect the SEC’s broader thinking about social norms and family constitution and tying those relationships to greater market access.

Changes for Entity Investors

1.  Regulatory Profile or Form of Certain Entities

• A new category of accredited investor has been added for those investors that are investment advisers registered under Investment Advisers Act of 1940, as amended (the “Advisers Act”), exempt reporting advisers under the Advisers Act and/or investment advisers registered under applicable state laws, regardless of whether such entities meet the $5M total asset threshold for entities generally under the accredited investor definition.

• Limited liability companies that have not been formed for the purpose of making the investment in a fund and that have total assets in excess of $5M will qualify as an accredited investor.  This change is more of a codification for how practitioners traditionally dealt with LLCs under the existing accredited investor definition than a material change to the fabric of the definition itself.

2.  General Catch-all Entity Category

A new category of accredited investor has been added for those entity investors that are not otherwise specified in the accredited investor definition and not formed for the specific purpose of acquiring the securities offered that owns more than $5M in “investments.”[iii]  It is important to highlight that this new category looks specifically to “investments” and not “assets” held by the entity, which is a change in construct from most of the primary financial determinations applicable to entities under the accredited investor definition.  Thus, not only does this new category not look to entity construction and constitution for purposes of meeting the accredited investor definition, it also veers away from the traditional asset-based mindset of analyzing whether an entity should or shouldn’t be considered an accredited investor.  This new more amorphous bucket will include entities such as Native American tribes, governmental bodies, foreign entities and other entities whose structure and nature do not fit within the other identified categories in the accredited investor definition.

3.  Family Offices and Family Office Clients

The Adopting Amendment has added a new category for those entities that (a) can meet the definition of “family office” pursuant to rules issued under the Advisers Act, (b) have at least $5M in assets under management, (c) were not formed for the purpose of making the investment in the fund and (d) are managed by an individual who has such knowledge and experience in financial and business matters that the family office is deemed capable of evaluating the merits and risks of the prospective investment.  Further, in the event that the family office can meet the above criteria, any “family client” of the family office (as defined by the rules issued under the Advisers Act) shall also be deemed to meet the definition of accredited investor regardless of whether such family client can meet any other parts of the definition of accredited investor.  Most family office structures can and do meet the existing rubric of the accredited investor definition, thus, the import of these new rules be mainly for non-traditional family office structures and/or family clients that may not themselves be eligible for accredited investor status.

Adopting Amendment Timing

While the Adopting Amendment was announced by the SEC on August 26, 2020, it will not become effective until 60 days after its publication in the Federal Register.

Parting Thoughts

Many funds and those investing in them are heralding the changes promulgated by the Adopting Amendment as an encouraging sign that the SEC is desirous of expanding market access to a greater number of investors.  Such parties view changes such as providing non-wealth based categories of measurement for accredited investor status, expanded categories and natures of entities that can qualify for accredited investor treatment and revisions to the accredited investor rules to take into account evolving social norms and ideals as necessary steps in the right direction. 

The above notwithstanding, given that the Adopting Amendment did not make any inflation-based adjustments to the existing financial thresholds applicable throughout the accredited investor definition, many (if not most) individuals that can meet the new and/or expanded categories will likely already have satisfied the language and requirements under the existing accredited investor rules.  Thus, it remains foggy at best as to the actual number of additional investors that will be eligible for accredited investor status, and thus, access to private fund and other securities offerings.  While we hope that these new changes effectuated by the Adopting Amendment do, in fact, live up to the promise and intentions pursuant to which they were enacted, only time will tell just how much of a true impact they will have given the above.

Regardless of the ultimate direction these additions and changes to the accredited investor rules take us, we do know that their effective date is fast approaching us.  To get prepared, your fund subscription agreements, transferee investor questionnaires and other recordkeeping efforts related to oversight of your investors’ accredited investor status should be made ready for the changed rules, especially for any funds or other vehicles you are managing that will have a closing after the effective date of the Adopting Amendment.  We encourage you to call your fund counsel soon and consult with them on the best plan for getting your documents and operations in order related to these issues moving forward.

[i] For instance, an individual could only be considered an accredited investor if such individual either had (a) an income in excess of $200,000 in each of the two most recent years or joint income with that individual’s spouse in excess of $300,000 in each of those years and had a reasonable expectation of reaching the same income level in the current year or (b) a net worth, or joint net worth with that individual’s spouse, in excess of $1,000,000.

[ii] See Footnote 1 for clarification on income and net worth thresholds for individuals.

[iii] “Investments” are defined by reference to Rule 2a51-1(b) under the ICA, which is used to determine an investor’s status as a “qualified purchaser” under such rules.

Key Insights

On executing deals in the pandemic: The venture capital market is very connected. Although, for instance, Vietnam has managed COVID really well, it’s still difficult to fly to that country from Singapore or Indonesia. This makes doing deals in these markets nearly impossible even with COVID being managed.

On building a portfolio in an evolving market: As a firm, we have always looked closely at consumer behavior across Southeast Asia. … Leveraging data allows us to follow these trends closely and find investment opportunities accordingly.

On which COVID adaptations may be here for good: Currently, our investment team spends more time on desk research. This is an interesting development, because desk research and expert reviews give a more neutral view on the scalability of a business. Deeper research will definitely remain an important part of the investment process.

Read Full Commentary from Michael Lints

Read Full Report

Key insights

On how US/China trade tensions are impacting VC investing: China tech and healthcare investments into the US have dropped 90% as a result of trade tensions. In the meantime, more European and Southeast Asian companies are fund raising in China.

On the economic impact of coronavirus: Many businesses are adversely impacted given China and, increasingly, many countries across the globe are taking a cautious approach to control spread of the virus. The financial market had its biggest drop since 2008. In some sectors, we have seen an uptick in their business, including online education, food delivery and, in the healthcare sector, diagnostic and lab tests, to name a few. Companies that have filed for an IPO have delayed, as it is difficult for management teams to go on roadshows with the quarantine requirements. We had a Shanghai Stock Exchange Science and Technology Innovation Board (STAR Market) virtual IPO recently, where the official ceremony was postponed but the trading of the stock began and performed very well. We hope things will be back to normal soon.

VC deal terms favoring investors: The investment pace has definitely slowed down in Q1 in China, but we are still seeing activities as investors perform their due diligence online and through video conference. One of our companies just closed a $100 million round, and one received six term sheets last week. 

Read Full commentary from Nisa Leung

Key insights

On asking for help from your investor: Repeat entrepreneurs ask for help more frequently. When you need help, ask for it. That’s what we are here for.

On building and retaining fans of your business: Having advocates in your customers, your employees and your board is paramount to your success. As you grow, keeping these people on board is even more important.

On company growth potential: I often ask entrepreneurs: “If your company had $30 million in the bank, what would you be doing differently?” If their answer sounds like a solid and promising growth trajectory, then why aren’t we pursuing that path?

Read full commentary from Anna Patterson

A few highlights

On technology companies driving valuations to historic highs: “Software is eating the world, and it has a voracious appetite. … Against a backdrop of sweeping technological change, the right companies have an opportunity to be truly gigantic.”

On European deal term trends: “This feels like a healthy place to be. Entrepreneurs are no slaves to investors, but, equally, investors are able to exercise appropriate fiduciary responsibility on behalf of their own backers.”

On how Brexit could affect the UK startup community: “My biggest long-term concern is that a hard Brexit and nationalistic rhetoric will fundamentally damage Britain’s hard-earned reputation as a welcoming, supportive home for ambitious folk from the world over.”

Read full commentary from Suranga Chandratillake

A few highlights

On the current market: “It’s an ebullient time with plenty of cash in the ecosystem, rising valuations and – importantly – a huge wave of liquidity.”

On the future: “It feels like a gold rush mentality amongst investors right now, who are willing to fund pretty much anything that moves. What matters is how long that lasts, and it certainly can’t last forever.”

On Lux’s strategy: “Our preference is to invest in areas where we can maintain some price discipline. This means pursuing ideas that may be unpopular or outside others’ domains or, in some cases, ideating and funding companies at inception.”

On the proliferation of venture capital: “It’s not just a great time to be an entrepreneur, but a great time to be a new GP, in that you’re seeing thousands of new firms get started with individual partners from larger organizations branching off on their own or angel investors starting to institutionalize.”

Read full commentary from Zack Schildhorn

A few highlights

On the atomization of seed rounds: Often founders are raising multiple seeds – sometimes raising their institutional seed after already raising over a million dollars, whether through a “friends and family” round or a pre-seed round.

On the availability of capital: I think capital constraints are good for a company and a founder to force them to stay focused on proving the core hypothesis instead of spreading their resources and team over many different [ones].

On consumer tech: We’re actually seeing a lot of consumer companies that aren’t software based and instead operate in the real world with physical assets. … For us as a tech VC, it feels like that’s on the edge of our investment thesis.

Read full commentary from Hayley Barna

A few highlights

On deal terms: The pendulum is definitely favoring entrepreneurs and founders, which in life sciences also typically includes venture creation-focused investors.

On shifting dynamics: These trends bring life sciences terms closer to where technology terms have been in recent years – where companies and entrepreneurs have many options to play off each other.

On pharma deal flow: There’s been a real disconnect between pharma partnering and the equity capital markets recently, in particular around M&A. … If the equity markets cool considerably, I would anticipate an increase in pharma dealmaking. 

On market outlook: I think we’ll see a cooling of venture financing and public offerings through the end of 2018 with a likely resurgence in early 2019 as markets stabilize and IPO activity picks up again.

Read full commentary from Bruce Booth

A few highlights

On deal terms: Generally, the terms have been company and entrepreneur favorable for a long time now, and they continue to remain that way.

On the proliferation of late-stage investors: It’s created this downward movement on stage of financing, and therefore upward pressure on what a normal Seed or Series A round looks like.

On Bessemer’s response to the influx of capital: We’re doing a lot more earlier-stage investing. The key to moving earlier is to know when to double down on your winners.

On fewer IPOs: There’s a lot more talk about companies staying private, and I don’t necessarily think that’s a bad thing … by definition if you have more time to mature, you should be more predictable and stable in your growth profile and earnings potential, which is generally more attractive to public market investors over the long term.

Read full commentary from Stephen Kraus

A few highlights

On his market outlook: Overall, I am extremely bullish as technology continues to be a major contributor to the US economy, and I do think disruptive technology and business models will continue to change many aspects of healthcare, consumer and enterprise opportunities.

On valuations: With so much capital deployed over the past several years, valuations seem to have cooled for some companies needing more time to get aligned with the “rule of 40” metrics.

On sector trends: There continues to be a demand for breakout enterprise security opportunities, multitenant cloud-based applications, artificial intelligence augmentation and robotics. We also see a huge white space in solving real-world consumer problems like urban mobility, living spaces and the future of work. We’re also tracking innovative technologies that will make healthcare more personalized, efficient and cost effective.

On exit routes: I expect, based on 2016 and 2017 data, that more often than not, companies will go the M&A route.

On M&A: Q1 2018 saw a huge increase in the tech M&A market from non-tech buyers. Transactions led by non-tech buyers nearly tripled from Q4 2017.

Read full commentary from Anna Patterson

In order to navigate these potentially choppy waters, a firm should prepare well in advance for – or at least educate itself as to – the various issues and considerations than can arise in such a situation. This education and preparation process should begin at the inception of the firm, with thoughtful consideration of the terms of the governing agreements of the management company and first general partner (GP) entity, which will become a critical base of support for the firm’s long term health. The analysis should not stop there, however, as a firm should re-visit these issues throughout its life based on the particular circumstances it faces and experiences it may have. The approach here must be dynamic and flexible, as if you simply analyzed and drafted a form of these agreements 20 years ago and continue to simply “clone” them over time, you may be missing out on capturing more recent market practices which can serve to better protect the organization in the face of MD departures. Our most mindful clients regularly engage with us to strive to have the most company favorable terms in their documents, with a view of organizational health and stability.

While each MD departure situation has its own unique attributes, when counseling clients in these circumstances we generally cover the same basic list of issues and considerations as a starting point for helping our clients find the best way forward. Most often, the resolution of these issues between the firm and the departing MD is encapsulated in some form of separation and transition agreement that is drafted by us, as fund counsel, in conjunction with our employment lawyers to assist with the employment-related considerations. What goes into such an agreement and what are those core issues that a firm can expect to deal with an manage around when an MD departs? Let’s tackle them in turn.

What do existing governing agreements provide?

The starting place for analysis in the face of an MD departure is to look at the “upper tier” organizational documents referenced above. As stated, these set up the basic set of ground rules for the departure. These agreements may differentiate treatment of a departing MD based on whether the MD is departing voluntarily or involuntarily, and in the latter scenario whether such departure is “for cause” or “not for cause.” The governing agreement for management company entity, if drafted with a company viewpoint in mind, is likely to have a “buy back” provision where the management company can repurchase a departing MD’s interest therein for some price (e.g, the relative capital account balance of the departing MD as of the departure date), though in some cases there may be more complex pre-negotiated severance terms in the agreement that have to be considered and complied with.

For GP entities, the underlying agreements very likely will have: (1) a set of vesting rules in place that apply to the departing MD’s carried interest therein; (2) rules about the MD’s capital commitment to the GP entity on a going forward basis, which may call for full contribution or may scale back the commitment to allow others to take up the corresponding investment; and (3) many other smaller rules, for example regarding potential future dilution for admission of additional members, ongoing obligations, etc. Importantly, some agreements that are very company favorable may have complete buyout provisions at the GP level (including of all vested components, like vested carry) to permit the GP entity to “entirely rid itself” of a difficult departee, such as one that leaves amidst a lawsuit or goes to work at a competitor. In the case of both management company and GP entities, the departing MD also almost invariably loses his or her future right to vote and any other management authority with respect to matters related to these entities.

Timing of departure

While most often not an agreement driven issue, from an organizational perspective the timing of when an MD departs can be crucially important and should be carefully planned in advance, if possible. For instance, the timing of when an MD departs can potentially disrupt fund raising, raise securities laws issues (e.g., if the departure occurs soon after a fund has closed and the firm knew of the departure before the closing happened), implicate key person clauses in underlying fund partnership agreements (see more on this below), give rise to potential tax implications to a departing MD and the firm, and so forth.

In addition, if the departing MD is going to stay on as a consultant or serve in a lesser role than the historical one, thought needs to be given to the time periods for this type of multi-step transition and what it may mean for other issues, such as vesting.

Circumstances do sometimes mitigate that someone be immediately removed from employment with the firm (e.g., the departing GP has died, committed a crime or engaged in other salacious behavior), and in these cases timing is a triage matter as opposed to part of a dutifully considered transition plan. In any event, as you can see, the timing of when an MD departs can in certain circumstances be almost as important as the terms negotiated around such departure.

Compensation and equity interests

Depending on the circumstances and negotiated terms, the departing MD may receive severance payments or some form of transition period compensation if his or her level of engagement with the firm is scheduled to sunset over a negotiated time. As mentioned above, in a minority of cases the management company governing agreement may have pre-negotiated severance terms that must be complied with as well. A benefit of a firm paying additional compensation (i.e., compensation the departing MD is not already entitled to) is the firm’s ability to demand a release of claims in connection with the granting of such additional compensation. In addition to the separation agreement setting forth any residual equity and similar interests that the departing MD will obtain in the relevant upper tier entities (as mentioned above), it will also cover treatment of any parallel or side fund interests retained by the departing MD.

Messaging of departure

One of the most fundamentally important items to fully set forth with any departing MD is how, when and to whom either the firm or its personnel on the one hand and the departing MD on the other will communicate with the outside world regarding the MD’s departure. Most often, a full set of negotiated talking points are mutually drafted and a communications plan is put in place fully setting forth the details applicable to all parties about what they can and can’t say, to whom and when. The separation agreement will also often have a specific requirement for this communications plan and attach the talking points as an exhibit so all sides are on the same page regarding proper communications regarding the MD’s departure. This kind of concerted effort ultimately benefits everyone and provides a good playbook to follow.

Track record

The firm owns its track record but departing MDs will often seek to negotiate under what circumstances they will be allowed to use certain data for their future activities, particularly data surrounding the deals they have led or been involved in. Often the management company and GP entity governing agreements, if drafted properly, will have provision regarding ownership of track record and permit a departing MD to disclose a limited set of information in the future (and under what circumstances such disclosures may be made; for example, perhaps with advance consent as to form of disclosure by the fund manager). In absence of any such provisions, the negotiations on this issue can get a bit more muddied and contentious, but firms should be aware that this will likely be one of the key points up for negotiation in relation to an MD departure.

Releases

One of the most impactful legal provisions that a firm should be obtaining from a departing MD is a full release of claims against the firm, its personnel and affiliates. This is even more true in a contentious departure. Often the departing MD will ask for this to be a mutual release, which may or may not cause the firm heartburn depending on the circumstances surrounding the departure. The release question is a big one and should be fully considered with the input of counsel given the potential ramifications involved.

Key person test

Any potential or actual departure of an MD should cause the firm to look carefully at all applicable key person provisions in their fund partnership agreements. Triggering a key person provision can lead to whole host of consequences for the fund manager, from automatic suspension of a fund’s investment period to potential rights of the LPs to vote to terminate the fund (and other possibilities in between). Accordingly, as the timing of the departure is considered, the effect on the key person provisions should be considered and planned for carefully as well, to the extent feasible.

Other negotiated topics

Other considerations and issues that are often dealt with by firms facing a GP departure, typically housed in the separation agreement, are as follows:

• Continuation of health, dental and vision benefits
• Continuation of 401(k) and other similar retirement benefits
• Expense reimbursement
• Return of company property
• Continued use of office & secretarial support
• Confidentiality
• Future cooperation
• Non-disparagement
• Non-solicitation (of employees and investors)
• Arbitration

Final thoughts and takeaways

Having counseled over the years on hundreds, if not thousands, of MD departures, a fundamentally important observation we have about firms that have successfully navigated their way through these circumstances is that those firms that were well prepared in advance on the issues noted above were the ones that ultimately had the more satisfactory outcomes. While often times an MD departure will wind up in a big negotiation where there will be give and take on all sides, the successful firms know in advance where they have leverage (e.g., through the provisions in the management company and GP entity governing agreements, which hopefully are well set up with a company favorable view) and where they don’t (e.g., they may need a departing MD to stay on board for a certain amount of time and/or continue to fulfill certain duties). They also know how best to counterbalance those considerations and be amenable to going “off script” to achieve a good outcome. As the saying goes, one who fails to prepare has ultimately prepared to fail and we’ve seen that time and again in these MD departure scenarios.

One last note in relation to planning and MD departures is a word to the wise regarding generational planning at the upper tier level. Too many firms have either unartfully implemented or wholly ignored any plans regarding how best to introduce the next generation of great MDs within their own ranks. We have found that one of the most opportune times for firms to be thinking about potential promotion or managerial additions is often when an existing MD is leaving the firm. Economics may then already be shifting, voting concentration is being adjusted and team dynamics are changing. Accordingly, these are often the best of times to execute on generational planning matters, which our best managed clients are continually focused on.

On market fluctuations: Investing is a cyclical business, but we continue to feel good about our outlook because we generally take a long-term view, backing seasoned management teams and differentiated technologies with significant capital to weather transitory fluctuations.

On SoftBank’s position: The thrust of where we play the best, and where we are the best partner, is where we are going to become a patient, strategic shareholder and partner to management teams and earlier investors that are willing to take a long-term view with us.

On M&A: With tax reform and the repatriation of cash, M&A should continue to be robust. That’s also an opportunity for us as we look for strategic partners for our portfolio companies.

On cautious optimism for 2018: It doesn’t mean that we’re not cautious. We are highly selective in our investments, but, at this point, we are cautiously optimistic about 2018.

Read Cooley’s full interview with Michael Ronen on Cooley GO.

In the fourth quarter of 2017, both deal volumes and aggregate dollars raised remained robust and consistent with prior quarters. Cooley handled 246 disclosable deals representing more than $6.2 billion of invested capital. The invested capital figure was the highest quarterly number we have seen since the inception of this report 14 years ago.

For the overall year, we handled 945 disclosable deals representing more than $19 billion of invested capital. These numbers again reached levels not seen for 14 years of reporting.

In Q4 2017, transactions did show a slight decrease in median pre-money valuations from prior quarters. During the quarter, median pre-money valuations decreased across all deal stages with the exception of Series A transactions. Late-stage financings saw more significant valuation decreases from prior quarters. This may point to a cooling trend around late-stage private company valuations as we move into the new year.

Overall deal terms remained company-friendly. In Q4 2017, the percentage of deals with no participating liquidation preferences reached 88% of transactions. We also witnessed a decrease in recapitalization transactions and the utilization of drag-along provisions.

In summary, the article notes that some hedge fund and real estate fund managers are rushing to set up Delaware LLCs to hold their carried interests. These Delaware LLCs would elect to be taxed as “S corporations”; the theory being that the new carried interest legislation does specifically say that the new law does not apply to carried interests held by “corporations” (and therefore the three year holding period would not be required to be met).

While it is technically true that the law mentions “corporations” broadly without distinguishing between “C” corporations (which pay corporate income tax at the entity level at 21% with a second shareholder level tax on dividends) and “S” corporations (which generally pass through their income to their owners so that there is only the shareholder level tax), this idea has been floating around out there since the new law was passed. We have been very skeptical that this would end up being a viable loophole. We have expected that either Congress would pass a “technical correction” which would fix this obvious workaround, or that Treasury and the IRS would issue regulations to do the same thing. The whole situation is an unfortunate byproduct to the legislation being passed with such haste (prior versions of proposals to change the tax treatment of carried interest were much more carefully and thoughtfully drafted).

Well, it turns out that someone in President Trump’s Cabinet is an avid reader of Bloomberg News. In the afternoon after the Bloomberg article was passed, Treasury Secretary Steven Mnuchin announced that indeed this S corporation “dodge” would be shut down and that this gambit would not be available to taxpayers to get around the law. Secretary Mnuchin said:

“We do believe that taxpayers will not be able to get that loophole. We will have that resolved.” He promised the Senate Finance Committee on February 14th that the government would act within two weeks to shut down this potential workaround.

Apparently the Trump Administration is all out of valentines for the private funds industry. Stay tuned to your Cooley team for further developments in the implementation of the new rules on carried interest.

The PPM is a disclosure document regarding the private offering of securities (namely, limited partnership or limited liability company interests) by fund managers and is meant to provide investors with a wide array of information about the fund, the fund manager and its organization to allow those investors to make an informed decision about investing in the fund. At the same time, through those same disclosures, the PPM provides the fund manager a degree of protection against later claims by the fund’s investors and others regarding misstatements and/or omissions of information by the fund managers during the fundraising period. In addition to these benefits, from a marketing perspective, producing a PPM provides a fund manager with a perfect opportunity to fully and thoughtfully tell the business story as to why this fund offering is unique, high quality and offers prospective investors the opportunity for positive investment returns. Moreover, some investors, particularly institutional investors, might in some cases require the production of a PPM before they will either take a meeting with a fund manager or move further down their investment process with that fund manager. In those investors’ view, a PPM “professionalizes” the marketing of the fund and the story behind it in a way that just an executive summary and/or slide deck can’t. Funds working with placement agents may be encouraged, sometimes strongly, by the agent to produce a PPM in order to improve the “best of breed” appearance of the fundraising effort. Finally, it is often the case that for those firms that have historically drafted and used a PPM in their prior fundraising efforts, investor expectations are such that the PPM will be expected to be produced as a matter of precedent and it would look too unusual and require too much explanation not to draft the PPM again (though of late, a number of very reputable firms raising sometimes very large funds have proceeded without a PPM, in the interest of time or otherwise, so the ice may be melting on this point).

On the flip side, some fund managers are looking to streamline the fundraising process as much as possible. Because preparing a PPM is not a legal requirement or condition, strictly, of having a legally compliant private offering of fund interests, a number of fund managers choose not to produce one, instead relying on other marketing materials and their meetings with investors to convey the information they wish to disclose to them. The PPM drafting process does take considerable time on the part of the fund manager, who is really the only party that has the ability to draft the business case. They are passionate about it, and understand it fully. It’s not a component that can be very successfully outsourced, though there are some marketing providers who provide ghost writing type services or sometimes even more robust services involving conceptualizing and framing the overall business presentation. The PPM also requires the review of fund counsel to fully and properly set forth the legal considerations and risk factors involved with the fund offering and vet through the business story for any potential legal missteps by clients in their wording. In addition, the PPM will require updating of information constantly over a long fundraising period (e.g., portfolio performance information, changes in fund terms, possible legal or tax changes during that time, etc.), and thus, more time required to be spent on the PPM by the fund manager beyond just the initial drafting. By making the decision to not draft a PPM, a fund manager can save a lot of time and money, but at what cost?

We have seen fund managers of all shapes and sizes make all types of decisions on this issue based on the factors noted above and sometimes others. Some feel that producing a high quality PPM and its attendant benefits of greater risk minimization, an additional opportunity to fully tell the business story behind the firm and the fund and the potential for greater receptivity by institutional investors outweigh the time and cost saved by not drafting one. A competing view that we see quite often, particularly of late given the busy enviornment and haste of many offerings, is that drafting the PPM is a time consuming, costly and unnecessary extra step for the fund manager in an already tough fundraising environment. In some cases, the envisioned LP base may be viewed as not really interested or in possession of sufficient time to process such a long document – i.e., perhaps they prefer a slide deck in some cases.

The right decision for a firm depends entirely on their respective approach to these issues, taking into careful account the size and nature of fund, the LP base, and so forth. No matter the approach, many issues are involved in making this decision and having an experienced fund counsel like Cooley can greatly help you scope out the various considerations to be thinking about regarding this decision.