If you are an emerging fund manager, you may have wondered about the maximum number of investors that can subscribe to your fund. Are there any government restrictions on this number, and how can you use parallel funds to bypass it if it contravenes your fund thesis? This article will help you fine-tune your fundraising strategy.
Investment Company Act
Most venture capital funds qualify for an exemption from registration as an investment fund under 3(c)(1) of the Investment Company Act of 1940. While this exemption saves funds from having to make lengthy, periodic government disclosures, it also imposes certain restrictions on fund operations. For example, venture capital funds are limited to a maximum of 250 investors, and private funds are limited to only 100 investors.
What happens, then, if you are aiming for a larger number of investors to subscribe to your fund? Most attorneys would recommend creating a parallel fund under 3(c)(7), another exemption of the Investment Company Act.
Parallel Funds
Parallel funds are investment vehicles set up under a main fund that are strikingly similar in investment strategy and operational model. They also invest into the same portfolio companies or projects on a pro rata basis, based on the available funds in each parallel fund. Fund documents reflect this close relationship accordingly, with the same fund manager in charge of all the parallel funds.
If your fundraising strategy targets more than 250 investors (if you plan on setting up a venture capital fund) or 100 investors (if you plan on setting up a private fund), then you may consider setting up a parallel fund under 3(c)(7). This exemption has a maximum limit of 2,000 investors, which is more than enough for most emerging funds. Both funds can invest in the same portfolio companies or projects and pursue the same investment strategy and operational model.
Organizing Investors Into The Funds
Funds qualifying under 3(c)(7) require investors to be at a higher financial level than funds qualifying under 3(c)(1). What is the difference, exactly? The former requires investors to be qualified purchasers, while the latter requires investors to only be accredited. Qualified purchasers are individuals or entities with investments under management of over $5 million. Accredited investors are individuals earning more than $200,000 per year in income, or entities with assets of $5 million or more.
Next Steps
To determine if you will need to set up a parallel fund, consider your investment strategy. Do you really need to have parallel funds investing in portfolio companies or projects on a pro rata basis, or can you set up separate investment vehicles to follow different investment strategies? In other words, if you have more than 250 investors, can you simply put them into different special purpose vehicles or funds to invest in different portfolio companies or projects rather than clumping all the investments together?
