As of 01 March, the newly revised EuVECA regulation is in effect. The EuVECA regime, which has only received little attention from the industry, will likely see a rise in popularity with managers of Venture-Capital and Growth-Funds and potentially even with managers of Small-Cap-Buy-Out-Funds.
This SMP Briefing aims to present the EuVECA regime, highlight the newest revisions and describe for whom the EuVECA regime might be of interest.
Most German managers of Private-Equity- and Venture-Capital-Funds manage their funds as so-called Small AIFMs with a registration pursuant to § 2 para. 4 KAGB (also called “sub-threshold managers”). This is a very simple regime, which neither demands much from the manager during the registration procedure nor afterwards.
Prerequisite to obtaining such a registration is that all investors in the managed funds either qualify as professional investors under MiFID or as semiprofessional investors under KAGB. Professional investors are in practice mainly institutional investors. Semiprofessional investors under the KAGB are investors which need to subscribe for a capital commitment of at least 200,000 Euro and the manager is required to confirm, after having made an own assessment, that the investor possesses sufficient knowledge and experience to conclude the investment.
Additionally, the value of managed assets, i.e. the active portfolio companies, may not exceed 500 million Euro (balance sheet values according to the German Commercial Code) and no leverage may be employed at fund level.
This “sub-threshold regime” however has one serious drawback: fundraising on a pan-European level outside of Germany is only possible to a limited extent. If and to which extent it is possible relies on the relevant national marketing regimes of the respective EU member states. Marketing is, for example, possible in Luxembourg and the United Kingdom, whereas it is not possible in France, Austria, the Netherlands and Denmark. And even if marketing is possible, it is in most cases only permitted towards institutional (professional) investors and not towards high-net worth individuals, family offices or endowments/foundations.
This is completely different for EuVECA-registered managers. EuVECA managers may market their EuVECA funds throughout Europe, without limitation, to professional investors under MiFID and to semiprofessional investors under the EuVECA definition. The practice of some member states charging additional fees for granting a marketing license has also been abolished in the course of EuVECA revision.
The semiprofessional investor definition under EuVECA also has two major advantages compared to the definition under the KAGB: Firstly, the minimum subscription amount is only 100,000 Euro instead of 200,000 Euro. Secondly, the manager does not need make an own assessment of the investor, which, when the fund is not performing well, can sometimes become a point of dispute.
Marketing outside of the Europe, for example in Switzerland or the US, is the same under both regimes and solely depends on the marketing regimes applicable in the target jurisdiction.
The requirements for a EuVECA fund are now so broad that Venture-Capital funds should generally meet the requirements. Additionally, Growth and Buyout funds can also fall under the EuVECA regime, depending on the circumstances.
A fund, which is to be distributed under the EuVECA regulation, must be established in an EU member state, may only admit professional and semiprofessional investors (see above) and must adhere to certain investment restrictions. Investments by the team of the manager are permitted.
The investment strategy of the fund must foresee that at least 70% of the aggregate capital contributions and uncalled committed capital (also sometimes called “investment capital”) is to be invested in qualifying investments. Accordingly not more than 30% of the investment capital may be invested in non-qualifying investments.
Qualifying investments are equity or quasi-equity instruments in qualifying portfolio companies (see below) as well as (to a limited extend) shareholder loans to qualifying portfolio companies. The quasi-equity instruments can be acquired by new issuance or exchange of shares as well as acquisition of existing shares. The latter therefore makes the EuVECA regime interesting also in Buyout situations. Shareholder loans may not exceed 30 % of the investment capital.
The scope of qualifying portfolio companies has now also been expanded: going forward, all unlisted undertakings which employ less than 500 persons will qualify. Annual turnover figures and balance sheet value are not relevant factors anymore. In addition, SME undertakings which are listed on an SME growth market may qualify, provided their average market capitalization is less than 200 million Euro.
It has now also expressly been clarified that the aforementioned requirements must be met by the portfolio company at the time of the first investment by the fund. The fund may therefore keep making further investments if the portfolio company is prosperous, irrespective if the portfolio company itself exceeds the 500 employee or 200 million Euro thresholds.
The portfolio companies must be established in an EU member state or in a third-country with whom tax cooperation agreements are in place and which is not blacklisted on the FATF list of countries with a high anti-money laundering risk.
Similar to the registration as a sub-threshold manager pursuant to § 2 para. 4 KAGB, leverage may not be employed at fund level and the “exposure” of the fund may not exceed the remaining, uncalled capital commitments.
A EuVECA manager will subject itself to a “regulation light”. The requirements go slightly beyond those of a mere registration as sub-threshold manager, but are substantially less than what is required under a full AIFMD license. In practice, the requirements should not exceed what should be perceived as industry standard practice with respect to investment activities of a fund.
A EuVECA manager must also file the same annual reporting on its assets under management which a merely registered sub-threshold manager is required to submit.
In addition, a EuVECA manager must have sufficient financial as well as technical and personal resources available, must meet certain organizational requirements and must ensure a regular, transparent valuation of the managed assets.
The “own funds” requirement was in the past often a point of discussion in the registration process of a EuVECA manager, as the German regulator’s (BaFin) understanding of “adequate” kept reaching new highs.
The requirements have now been concretized: the manager is required to have at all times an amount of own funds equal to at least one eighth of the annual fixed overheads, but in any case no less than 50,000 Euro. If the manager has assets under management in excess of 250 million Euro, additional own funds have to be held equal to 0.02 % of the amount by which the assets under management in the EuVECA funds exceed 250 million Euro. Up to 50 % of such additional own funds may be provided by a guarantee of a credit institution or an insurance company.
Own funds must be available in cash or invested in liquid assets or assets readily convertible to cash in the short term. They must hence be “parked” and cannot be used as working capital.
The manager must have an adequate internal organization in place and must ensure that conflicts of interests are avoided respectively disclosed. This should in practice already be the case for most managers. Already existent internal procedures will then only need to be fixated in writing (and be adhered to in the future) and some of the tasks may need to be put on different shoulders.
At least once a year the manager is required to conduct an adequate and transparent valuation. This requirement should be met if the valuation is conducted, which is market standard, based on the current guidelines of the IPEV-Board.
During the fundraising as well as in the ongoing reporting afterwards the manager is required to meet certain transparency requirements, which in practice, however, should not exceed what is current market standard anyhow.
The EuVECA regime has also been opened up to fully licensed managers, which intend to subject their funds to the EuVECA regime. The benefit of this is that such managers would not only have recourse to the EU marketing passport under the KAGB/AIFMD (which allows for marketing to professional ,and in some countries semiprofessional, investors), but would also allow for marketing to semiprofessional investors as defined under the EuVECA (see above).
While the registration process was a bit of a hassle and fairly unpredictable in the early years, this has changed in recent times. The responsibilities are now concentrated in one BaFin department, which makes the registration process much more reliable and predictable.
In addition, the revision of the EuVECA regulation removed most of the remaining obstacles. Subject to good preparation, a successful registration should thus be achievable in a timely and plannable fashion.
In the course of the registration procedure the manager must demonstrate how it intends to meet the requirements of the fund and of the manager. The manager will typically submit drafts of the fund documentation, i.e. limited partnership agreement and PPM, as well as the written internal organizational guidelines. The managing directors of the manager must additionally demonstrate their integrity and experience by providing detailed CVs and registry excerpts. The prior discussion point of the own funds requirement now should be a thing of the past, as the manager will only need to demonstrate the availability of sufficient own funds based on the preceding – or if the manager is newly formed – planned annual fixed overhead.
The European Securities Market Association as the European supervisory authority will also publish technical standards, templates, forms and procedures in the future to further streamline the registration process across the European Union. If such a streamlining will be a blessing or curse remains to be seen.
As for timing, the revision of the EuVECA regulation now also introduced a maximum turnaround time of two months after submission of a complete registration. The registration procedure can therefore – as has been done in the past – not be artificially extended by referring to other matters with deadlines.
Any subsequent amendments to the information included in the registration must be disclosed to the regulator in advance. The regulator then has one month, with a possible extension to two months, to assess these amendments and approve or disapprove of them.