When the 10-year-old venture capital firm, Andreessen Horowitz, decided to give up its venture capital business in 2019, it was as though the firm was bringing the entire venture capital industry to a crushing end. This was not, in any way, the end Marc Andreessen and Ben Horowitz, founders of Andreessen Horowitz, saw ten years ago in 2009 when they set up the traditional venture capital firm. And for a business that has over $28.2 billion in Assets Under Management (AUM), it would appear foolhardy to imagine that it was on the edge of bankruptcy. But was it? Andreessen Horowitz — or a16z (as it is briefly called) — was simply responding to an existential threat. Joined by other venture capital firms, such as General Catalyst, Touchdown, the Foundry Group, Sequioa, Bessemer Venture Partners, a16z understood the job of every business manager: to constantly evolve to remain competitive. All mentioned VC firms have relinquished the title of “venture capital firm” in preference to “investment adviser.”
But Why An ‘Investment Adviser’?
As would be shown in the comparison table below, venture capital firms are constrained in their capacity to invest outside of the typical startup scene, a sector that has become flooded with record amounts of cash as a result of enormous funds such as SoftBank’s $100 billion Vision Fund.
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By becoming a Registered Investment Adviser (RIA), Andreessen can invest more capital in areas such as cryptocurrency, which frequently includes the acquisition of tradable coins as opposed to equity, and can let analysts from diverse fields to speak more openly with one another, as opposed to being walled off.
| S/N | Queries | VENTURE CAPITAL FIRMS (VCs) | REGISTERED INVESTMENT ADVISER (RIAs) |
|---|---|---|---|
| 1 | What can this type of structure do? | VCs provide investment advice to the funds they manage and then manage the portfolios. | RIAs primarily provide advice on securities or other investments to clients and manage their portfolios. |
| 2 | At what point is registration required for each to offer services offered by the other? | VCs provide services offered by RIAs only to the extent of the funds and portfolios under their control. Therefore, registration as RIAs is required if VCs want to offer services primarily offered by RIAs. However, there are situations when VCs may offer services offered by RIAs without registration as RIAs. These situations can only arise only if VCs can show that: They only use a venture capital strategy within a private fund structure to manage the investments. At least 80% of the VC’s fund’s assets is invested in the stock of a private portfolio company, and that portfolio company does not borrow money or issue debt in connection with the private fund’s investment (i.e. no leveraged buyouts). If a VC wants to invest in secondary offerings, other venture funds, or the public equity of a company they took public, they can only do so with 20% of their fund’s total assets. | RIAs can provide venture capital services offered by VCs only to the extent of the clients and portfolios under their control. Therefore, registration as VCs is required if RIAs want to offer services primarily offered by VCs. |
| 3 | What are the major regulatory advantages and limitations in choosing one for the other? | VC companies can register as “exempt reporting advisers” or ERAs under US SEC laws. This lets them invest in startups without many compliance hassles. However ERAs, VC funds must limit non-qualifying investments (such as secondary offerings, crypto, or other venture funds) to less than 20% of their assets. | RIAs don’t have any such 20% cap on their assets. However, being an RIA comes with severe constraints including audits and advertising regulations that make cheerleading for a company harder. Upon SEC registration as an RIA, an RIA must adopt and frequently evaluate policies and procedures controlling almost every element of its activity. These obligations stem from the 1940 Investment Advisers Act. Particularly, RIAs should address the following policy and procedure issues: ( portfolio management processes, including allocation of investment opportunities — especially if they are limited as venture capital investments tend to be; insider trading; safeguarding of client assets; marketing activities; valuation of investments; client privacy; record-keeping; business continuity plans; cybersecurity; disclosure to clients and regulators; surfacing and managing conflicts of interests; The employees and certain consultants of the RIA must adhere to a code of ethics which govern certain behaviors outside of work such as personal trading, other business activities, gifts and entertainment, and conflicts of interest; finally, an RIA must have a dedicated Chief Compliance Officer who is responsible for administering the policies and procedures. Thus, although RIAs have more flexibility investing, this usually comes at a higher compliance cost. |
| 4 | What is the fundamental difference between an RIA, VC and a broker dealer? | VCs provide investment advice to the funds they manage and then manage the portfolios. A broker dealer does not. | Legal obligations and compensation are the main differences between RIAs and broker dealers. An RIA has a fiduciary duty to its clients, while a broker dealer is held to a suitability standard, meaning its advice must be suitable for the client’s need at that time and not always what is best for the client. Fiduciary obligation is a higher standard than suitability. Broker-dealers are paid by commissions on the investment products they sell. An RIA charges its clients (or fund) a proportion of assets under management, a fixed or hourly fee, or an incentive fee if assets rise in value. Furthermore, whereas broker dealers are members of FINRA, which is regulated by the SEC, RIAs are registered with the SEC or a state securities regulator. |
Which Direction Should African Venture Capital Firms Take?
While the startup funding landscape in Africa is still growing and concern is more focused on getting more venture capital firms to join the investment space, knowing which path — venture capital or investment adviser model — to follow could only serve, for now, as a strategic tool for wriggling out of the growing competition in the investment landscape.
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However, given that a majority of African venture capital firms are headquartered in the US, it makes more sense to substantially comply with the rules and regulations of the US. For example, as of December 2021, no venture capital fund has been registered with the SEC in Nigeria.
The size of a VC’s fund and its investing strategy should primarily determine which of the paths to toe. Where it chooses the VC path, it must limit its non-qualifying investments (such as secondary offerings, crypto, or other venture funds) to less than 20% of their assets in keeping with the SEC rules, as discussed above. Fortunately, the US DEAL Act, introduced in the US House of Reps last year, seeks to update the definition of a qualifying investment to include secondary transactions and allow venture funds to invest in other funds without counting against the 20% limit. This is part of major lobby efforts by the US’ National Venture Capital Association (NVCA), to “modernize” what it means to be a venture capital firm
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For funds registered in respective African countries, local laws should apply; however, it must be borne in mind that a majority of African countries still frown at certain investments in alternative asset classes such as cryptocurrency.
venture capital VCs Africa venture capital VCs Africa venture capital VCs Africa
Charles Rapulu Udoh
Charles Rapulu Udoh is a Lagos-based lawyer, who has several years of experience working in Africa’s burgeoning tech startup industry. He has closed multi-million dollar deals bordering on venture capital, private equity, intellectual property (trademark, patent or design, etc.), mergers and acquisitions, in countries such as in the Delaware, New York, UK, Singapore, British Virgin Islands, South Africa, Nigeria etc. He’s also a corporate governance and cross-border data privacy and tax expert.
As an award-winning writer and researcher, he is passionate about telling the African startup story, and is one of the continent’s pioneers in this regard. You can book a session and speak with him using the link: https://insightsbyexperts.com/view_expert/charles-rapulu-udoh