How SEC Regulation D hearings may affect VC firms

by Cornelius Harmon

For the vast majority of startup founders, venture capital funds are an important part of raising capital to continue running and scaling their businesses. However, in recent months, several well-known companies that raised hundreds of millions of dollars in VC firm investment have been accused of doing so under false or fraudulent pretenses, resulting in massive losses for both VC firms and the investors that provide them with capital for their funds. That has caused regulators and investors alike to call for a closer look at Regulation D Offerings, or those which do not have to be registered with SEC due to various exceptions and exemptions under the Securities Act. 

The SEC website states that, “even if a company takes advantage of an exemption from registration, a company should take care to provide sufficient information to investors to avoid violating the antifraud provisions of the securities laws,” and that is exactly what has sparked these conversations. High-profile cases of fraud have gone unnoticed in due diligence processes done by VC firms before and after making capital investments, and the repercussions have been devastating. Cases like these, as well as rising interest rates, highlight the reason why the SEC currently has a proposed rule being heard that would enable investors to bring legal action against VC firms for negligent or reckless practices. This proposed rule, which could be finalized as soon as early Q2 of 2023, may complicate relations between VC firms and their portfolio companies because venture-backed companies often don’t live up to their aspirations. 

This is largely due to the nature of the VC firm investment model, but other factors such as a lack of proper scrutiny by VCs, founder ineptitude, fraud, or difficult market conditions also contribute. Nevertheless, this new proposed rule may require VC firms to grow their teams that audit startups’ financials, and it also may make it more difficult for startups to secure funding, especially if their financial reporting is not airtight. And while it may save VC firms from feeling the pain of an investment gone bad, it doesn’t necessarily ensure that they will hit more home runs.

More Information

Investor.gov - SEC Reg D 

Politico - The legal threat coming for venture capital