Over the past few years, I’ve received an increasing number of calls from venture capital fund managers about continuation vehicles. More recently, I’ve been hearing from fellow regulatory lawyers who are encountering the same issue, particularly as venture capital exempt reporting advisers (VC ERAs) are exploring partnerships with registered investment advisers (RIAs) and larger investment platforms.
The question is simple: Can a VC ERA establish and manage a continuation vehicle without losing its exemption?
The answer, unfortunately, isn’t nearly as straightforward.
This year marks 15 years since the Securities and Exchange Commission (SEC) adopted Rule 203(l)-1, which defines “venture capital fund” for purposes of the exemption in Section 203(l) of the Investment Advisers Act of 1940 (Advisers Act). Much has changed in the venture capital industry since then. Companies are staying private longer, and secondary transactions have become a more important part of the venture capital landscape. There’s a good case for revisiting how the exemption applies to continuation vehicles.
The regulatory problem
Continuation vehicles have become increasingly attractive for VC ERAs. As private companies stay private longer, funds are holding portfolio investments well beyond their originally anticipated investment horizons. Some investors may be willing, even eager, to remain invested in promising companies. Others may need liquidity rather than another extension of the fund’s term. Managers may be reluctant to sell investments they believe have substantial remaining upside, and portfolio companies may benefit from continuing relationships with investors who understand their businesses and have supported them over time. A continuation vehicle can help accommodate these interests, allowing investors to obtain liquidity or maintain their exposure while the manager continues to support the portfolio companies. (For a more detailed discussion of continuation vehicle structures, see our primer, Continuation Funds in Private Equity and Venture Capital.)
But there’s a regulatory complication for VC ERAs. Section 203(l) exempts advisers from Advisers Act registration only if they solely advise venture capital funds. Under Rule 203(l)-1, a venture capital fund generally must limit its nonqualifying investments to 20% of its aggregate capital contributions and uncalled committed capital. Qualifying investments generally include equity securities acquired directly from qualifying portfolio companies. When a venture capital fund transfers portfolio company securities to a continuation vehicle, those securities generally become nonqualifying investments in the hands of the continuation vehicle because they were acquired from the predecessor fund rather than directly from the issuers. Because the transferred investments typically constitute a substantial portion of a continuation vehicle’s portfolio, the vehicle generally cannot satisfy the 20% limit on nonqualifying investments. And because Section 203(l) requires an adviser to solely advise venture capital funds, managing even one nonqualifying vehicle can jeopardize the adviser’s ability to rely on the exemption.
A VC ERA can continue holding portfolio company investments in the original fund without affecting their status as qualifying investments. But transferring those same investments to a continuation vehicle can jeopardize the adviser’s exemption, even though the underlying investments and investment strategy haven’t changed.
To be sure, the direct acquisition requirement serves an important purpose. When adopting the rule in 2011, the SEC explained that the requirement was intended to distinguish capital used to finance portfolio companies from capital used to trade in secondary markets. Transferring existing securities to a continuation vehicle doesn’t itself provide new capital to the portfolio companies, although the vehicle may separately make follow-on investments. But there’s a meaningful difference between a fund pursuing a secondary investment strategy and a continuation vehicle holding investments originally acquired as part of the adviser’s venture capital strategy.
The search for solutions
Managers and their counsel have been exploring a variety of approaches to address this regulatory challenge. Some managers have registered with the SEC to pursue continuation vehicles, although for many others, registration is not a practical option. Other approaches include partnering with a “friendly RIA” and allocating responsibilities between the VC ERA and the friendly RIA, or exploring alternative transaction structures, including statutory divisions under Delaware law. These approaches raise interesting questions, and some may work under appropriate circumstances. But they also require careful analysis.
For example, the involvement of an RIA doesn’t necessarily resolve whether the VC ERA is providing investment advice to the continuation vehicle. That determination depends on the parties’ actual activities and responsibilities, not simply their formal titles. And there’s an important asymmetry to keep in mind. The RIA doesn’t face the risk of losing the venture capital adviser exemption. The VC ERA does.
Similarly, Delaware’s statutory division provisions may offer a way to allocate assets among resulting partnerships without a conventional asset transfer under state law. But that doesn’t necessarily resolve whether the resulting vehicle has acquired the securities directly from the issuers for purposes of Rule 203(l)-1.
I’ve also seen questions about whether existing SEC staff guidance (discussed below) can be applied or extended to accommodate continuation vehicles. I’m not suggesting that these approaches are necessarily unworkable. Thoughtful lawyers are trying to address a genuine commercial problem, and the analysis will depend on the particular facts and circumstances.
That said, the growing interest in these structures illustrates why greater regulatory clarity would be valuable. It could promote more consistent advice, provide managers with greater confidence in their transactions, and reduce the need to rely on increasingly nuanced interpretations of rules and guidance that weren’t developed with modern continuation vehicles in mind.
Fifteen years later: The case for flexibility
When the SEC adopted Rule 203(l)-1 in 2011, it was implementing Congress’s decision to exempt advisers solely to venture capital funds while requiring most other private fund advisers to register or qualify for another exemption. The SEC appropriately sought to distinguish venture capital funds from leveraged buyout funds, hedge funds and other private funds that Congress hadn’t intended to exempt.
At the same time, the SEC recognized that venture capital business practices would evolve. Commenters had asked the SEC to accommodate future business practices that might not yet be known or contemplated. In response, the SEC modified its proposed definition and explained that the final rule was intended to provide flexibility for evolving business practices while preventing other types of private fund advisers from improperly relying on the exemption.
The SEC also recognized the importance of giving venture capital advisers flexibility to exercise their business judgment about when to dispose of investments. Although that discussion concerned portfolio companies becoming reporting companies, the principle is relevant as holding periods lengthen and managers consider continuation vehicles as an alternative to selling portfolio investments.
Fifteen years later, continuation vehicles present an opportunity to revisit how the rule accommodates evolving venture capital practices. The SEC staff could consider providing tailored relief for continuation vehicles subject to appropriate conditions. Such relief could preserve the distinction between venture capital investing and other investment strategies while accommodating a transaction structure that has become increasingly relevant to venture capital managers and investors.
A precedent for tailored relief
The SEC staff has previously recognized circumstances in which a strict application of the direct acquisition requirement may not be appropriate. In its December 2013 IM Guidance Update, the Division of Investment Management addressed several situations, including warehoused investments, transfers between parallel or side funds, and liquidating trusts established at the end of a venture capital fund’s term. In that guidance, the staff stated that it would not object to treating certain warehoused investments and securities transferred between main funds and side funds as qualifying investments, subject to specified conditions. More relevant here, the staff also stated that it would not object to an adviser continuing to rely on the venture capital adviser exemption when a fund transfers its remaining portfolio securities to a liquidating trust at the end of its term, with the adviser or an affiliate serving as trustee, and the possibility of such a liquidating trust having been disclosed in the constituent documents.
None of these positions directly authorizes a continuation vehicle. A liquidating trust established to wind up a fund’s investments is materially different from a continuation vehicle that admits new capital and continues managing investments over an extended period. The warehousing and parallel fund scenarios likewise address different situations. But the 2013 guidance demonstrates that the staff has been willing to take a more flexible approach to the direct acquisition requirement in appropriately limited circumstances. Instead of stretching existing guidance beyond its intended scope, the better approach may be to consider similarly tailored relief for continuation vehicles.
What about the DEAL Act?
As I discussed in my earlier FundLawyer post, Are Secondaries and Fund of Funds Investments on the Horizon for Venture Capital Fund Managers?, the Developing and Empowering our Aspiring Leaders (DEAL) Act would expand the scope of qualifying investments to include certain secondary acquisitions and investments in other venture capital funds. The House passed the DEAL Act in December 2025, and its substantive provisions were subsequently included as Section 109 of the House-passed INVEST Act. Under the legislation, these additional categories of investments generally could account for up to 49% of a venture capital fund’s aggregate capital contributions and uncalled committed capital.
The legislation has not advanced in the Senate, and the proposed 49% limit wouldn’t necessarily accommodate a continuation vehicle whose transferred investments exceed that limit. Nevertheless, the legislation is relevant to the broader policy discussion. It reflects recognition that secondary investments aren’t necessarily incompatible with venture capital investing. If a venture capital fund could potentially acquire portfolio company securities from unrelated third parties in secondary transactions, it seems reasonable to consider whether a continuation vehicle should receive tailored treatment when it acquires investments originally made by a predecessor venture capital fund managed by the same adviser.
A more practical approach
I began discussing this issue with staff in the SEC’s Division of Investment Management in 2025, exploring whether narrowly tailored guidance or no-action relief could permit VC ERAs to manage certain continuation vehicles without jeopardizing their exemption. I appreciate the staff’s willingness to engage with the issue, and I continue to believe it’s worth pursuing.
Any relief would need appropriate conditions. For example, it might be limited to continuation vehicles managed by the same adviser and its affiliates as the predecessor fund, holding portfolio investments originally acquired as qualifying investments by that fund, and continuing the original venture capital investment strategy. Additional conditions could address the circumstances of the transaction, disclosure and investor approval requirements, and safeguards against using continuation vehicles to pursue broader secondary or other non-venture capital investment strategies.
Importantly, such relief wouldn’t eliminate the other legal and regulatory considerations associated with continuation vehicle transactions. Conflicts of interest, valuations, disclosures, consent and fiduciary obligations would remain critical considerations. Here, the objective would be narrower: addressing whether the transfer of existing venture capital investments into a successor vehicle should, by itself, cause the adviser to lose its venture capital exemption.
I’d welcome hearing from venture capital managers and fellow regulatory lawyers who are navigating this issue. Their experiences could help inform the scope of any potential relief.
The authors
