A detailed explanation of RIA: A necessary license for venture capital funds to enter Web3?

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In June 2022, the SEC formally approved Bessemer Venture Partners’ application for an RIA license.

At the end of 2021, Sequoia Capital proposed in an open letter on October 26, 2021 that it would transform from VC to RIA (Registered Investment Advisor, registered investment advisor), which has aroused the market’s attention to the transformation of the venture capital industry. In fact, as early as 2019, the well-known American venture capital A16Z in 2019 has transformed into an RIA in order to meet compliance requirements when investing in cryptocurrency and blockchain projects.

What is an RIA? Why are VCs transitioning to RIAs one after another?

RIA (Registered Investment Advisor) license refers to a registered investment advisor in the United States and needs to apply for registration with the Securities and Exchange Commission (SEC) or the state securities department. Since VCs have been very interested in encryption and Web3 in recent years, in 2021, Thrive Capital was registered as an RIA, and in 2019, the well-known fund Paradigm was registered as an RIA, and the advantage of this structure for VCs is mainly flexibility:

“Because of the RIA license, more than 20% of the funds can be invested in liquid assets, including common stocks and secondary securities, encrypted assets, etc., but without RIA qualifications, VCs cannot invest in such assets. of.”

The reason why BVP chose to transform the RIA: Or to gain a competitive advantage, because whether it is the old venture capital fund A16Z, General Catalyst or Sequoia have embarked on the road of RIA, and various investments like Tiger Global Management and Coatue Management have done The fund has long been eyeing the venture capital track.

About RIAs and ERAs

RIA (Registered Investment Advisor) license refers to a registered investment advisor in the United States and needs to apply for registration with the Securities and Exchange Commission (SEC) or the state securities department. In the United States, only institutions or individuals with RIA licenses are qualified to provide investors with investment service advice on securities products, and provide investment reports on a regular basis.

Note that the scope of securities investment advice is quite broad in the United States, including asset management, account management and financial services in the entire securities market. Therefore, the asset pool includes common securities such as stocks, debts, mutual funds, and commodity futures. Hedge fund management and financial planning services are also defined as securities investment business.

The SEC’s approval of RIAs is very rigorous, and fund managers need to pass the Series 65 investment advisor exam (holding CFA and PFS licenses can be exempted from this exam). On this basis, it also needs to manage more than $100 million in assets to be registered with the SEC (AUM between $25 million and $100 million in assets is registered in the state).

On the other hand, the SEC’s supervision of RIA is also quite strict, and it requires registered investment advisors to protect the interests of their clients and not to deceive clients by improper means. First and foremost, we must maintain integrity with our customers, disclose information completely openly, and provide appropriate investment advice selflessly.

Secondly, the management of assets needs to go through a third-party organization, and the use of each payment needs to be notified and approved by the customer. This “fiduciary duty” is an operating rule imposed on registered investment advisers under the relevant Act, so that the interests of clients will be effectively protected. In addition, the SEC will regularly conduct surveillance inspections of RIAs. It mainly focuses on the risk supervision of the valuation, performance and asset review of the investment portfolio; the legal supervision of whether to provide effective compliance policies and procedures; and the announcement of the notice of the inspection results.

In general, the way to obtain an RIA license is quite strict.


What’s going on with RIA and ERA? What is the relationship with venture capital funds?

First of all, to understand RIA, we must first understand another concept, that is ERA (Investment Advisor exempted from reporting)

A detailed explanation of RIA: A necessary license for venture capital funds to enter Web3?

Traditional venture capital is regulated by the SEC as an “exempt reporting advisor” (Exempt Reporting Advisor, referred to as ERA). This concept originated from the Great Depression in the 1930s, when the United States launched a series of financial regulatory legislation. After the Securities and Exchange Commission was established under the Securities Exchange Act of 1934, the United States Congress passed the Investment Company Act in 1940 and The Investment Advisers Act establishes different regulatory rules for different investment funds.

The Investment Company Law is relatively strict and applies to large investment companies with more than 100 investors; the Investment Consultant Law is relatively loose.

Investing in startups through ERA is a lot looser on compliance.

Under the Investment Advisers Act, fund managers who manage more than $100 million but are not investment firms (ie, have fewer than 100 investors) should register with the SEC as an investment advisor (RIA). However, even if the regulatory requirements of RIAs are lower than those of public funds and investment banks, it is still too burdensome for small investment funds. For VC funds in particular, their business is simple: invest in startups and hold them there for years until an IPO (or other exit) occurs.

Regulators also believe that such businesses do not require frequent scrutiny. Therefore, the “Investment Advisors Law” has specially established exemption clauses, allowing investment funds engaged in simple businesses to provide only basic operating information without formally registering as an RIA, thus forming the ERA, a regulatory privileged group. For many years, the US venture capital industry has been protected and grown in an extremely relaxed regulatory environment by virtue of its ERA status.

Reference: Global Finance Magazine

Compliance Difficulty for RIAs

The RIA application process is lengthy and expensive, and if approved, venture capital firms face stricter compliance requirements, including the need to regularly disclose assets under management. As an exempt reporting advisor, a venture capital firm is not required to register as an advisor with the SEC.

However, in the case of ERA, venture capital firms can only invest up to 20% of the fund’s assets in other venture capital funds, digital assets, secondary stocks, etc., and others need to invest all in startups. Over the years, ERA is actually relatively stable Yes, but with more and more money flowing into private tech funds and the expansion of the venture capital industry, it’s more troublesome for many venture capital firms.

Because the provision of liquid secondary shares to founders and employees has become a more common part of VC deals, VC firms that hold these shares are likely to exceed the stated 20% limit, and VCs We are increasingly interested in cryptocurrencies, that is, startups can raise funds by selling equity or crypto tokens, and there is a need for more flexible RIAs.

other comments

In addition to BVP choosing to transform RIA, Upfront Ventures, an early-stage venture capital fund based in Los Angeles, will also transform into RIA. Greycroft also obtained an RIA license in January this year. And Upfront partner Mark Suster said that the main reason for choosing to become an RIA is to be able to buy more secondary stocks, or even buy a portfolio from another investment firm, and he wants to invest more flexible and creative.

He also said: I think the whole industry will eventually become RIA.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/a-detailed-explanation-of-ria-a-necessary-license-for-venture-capital-funds-to-enter-web3/
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