Venture capital is an investment strategy with a high risk. This type of investment is often used to fund a startup company that has a potential for growth. In 2000, the government created the Markets Venture Capital Program Act. This law allows the SBA to make regulations that are necessary to implement a venture capital program.
Venture capital is a method some businesses use to raise money. Typically, it is sought after by relatively new, privately held companies that would not be able to raise capital by other methods, such as obtaining a business loan from a bank. Companies successful in raising Venture Capital funds are usually poised for quick growth and have an innovative invention or idea that has the potential to lead to large profits. In the last two decades, several successful technology startups have relied on Venture Capital to raise money.
Venture capitalists, which are those who invest in the growing businesses, are often wealthy individuals, investment funds, or subsidiaries of investment banks. Venture Capital investors generally have a longer outlook for return on their investment and are willing to take a greater risk by providing unsecured loans to the target companies. In exchange, Venture Capital investors generally seek a larger portion of equity ownership in the company, a seat on the board of directors, and an active role in managing the company’s operations. Venture Capital investors make money when the company is acquired or merges with another company, or goes public by holding an IPO.
The investment is high risk
Venture Capital is financial capital provided to early-stage startup companies with a high potential for growth after the early growth funding round, also known as seed funding. These companies are aiming for eventual initial public offerings or even a trade sale. They are attracted to venture capital because most of them are too small to raise capital in the public markets, secure bank loans, or even complete debt offerings. As the investment is high risk, most venture capitalists gain significant control over company decisions and a large portion of the company’s ownership.
Venture Capital law involves many financing and M&A transactions, including public/private and private/private mergers, as well as acquisitions, extensive strategic partnering transactions (i.e., licensing matters, Original Equipment Manufacturers (OEM), reseller and Value Added Reseller (VAR) arrangements, technology development partnerships and other joint ventures). This type of law also includes many non-VC financing transactions involving the private and public sale of debt and equity securities.
Lawyers serving as primary counsel to emerging company clients are often viewed as outside general counsel. Lawyers provide extensive operational counsel on a wide range of matters that are pivotal for the emerging company and its investors, including employment matters, compensation issues, intellectual property protection, enforcement and monetization, and policy work. Understanding the client’s technology and the market in which it competes is crucial for the success of these operations.
Young companies interested in venture capital usually have rare, highly sought after qualities, such as innovative technology, the potential for rapid growth, or impressive business models and management teams. Because of the high risk and the need for high returns, venture funding is an expensive capital source for companies and explains its prevalence in fast-growing technological areas including clean tech and the life sciences. Depending on a venture capital legal practice’s size and availability of resources, startup clients may rely on them for virtually everything legal and quasi-legal. Entrepreneurs will involve their legal counsel in all of their new ventures and investor clients frequently refer their portfolio companies to the legal counsel.
Since venture capital is a type of private equity investment, the laws and regulations that affect private equity also apply to many aspects of venture capital investment.
Historically, private equity investments were lightly regulated. The Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. § 5301 et seq.) was passed in 2010, and it introduced several new requirements for investment banks, fund managers, and others in the financial industry. One important aspect of Dodd-Frank is a provision called the Volcker Rule. The Volcker Rule prohibits banks from using their own money—as opposed to money on deposit from customers—to make certain investments, including private equity. This means that generally banks cannot serve as VC firms.
After Dodd-Frank, hedge fund managers and private equity fund managers were required to register with the Securities and Exchange Commission (SEC). Venture capital managers were not required to register, but because of how the law defined venture capital funds, many entities that were primarily engaged in venture capital investments but had other holdings were subject to Dodd-Frank regulation.
In 2011, the SEC redefined what constitutes a venture capital fund, relieving many VC firms of the registration requirement and the need to provide detailed information to the SEC. Now, venture capital firms must have at least 80 percent of their money in qualifying investments, which are generally shares in private companies. As much as 20 percent may be in shorter-term investments for the firm to be exempt from the SEC registration requirement.
In 2012, Congress passed and President Obama signed into law the Jumpstart Our Business Startups Act (JOBS Act). The JOBS Act amended existing law with the aim of relaxing many requirements imposed by existing securities law. Along with changing some filing requirements for companies holding an IPO, the law lifted the advertising prohibition on venture capitalists and companies seeking private equity investments. Before the JOBS Act, VC firms seeking investors and private companies looking to sell shares could meet only with certain investors in private meetings. Now, these entities are free to advertise that they are seeking investments.