What does the VC market look like in late 2022? What jurisdiction do venture funds use to establish their operations? And which laws affect their business? I was able to talk to Shoira Turaeva, a legal professional working on the establishment of joint ventures as well as M&A deals since 2007, to discuss these and many other questions.
How does the venture market feel right now, in your opinion?
During the last decade, venture capital has been booming. Despite the dot-com bubble burst and the subsequent market crash of the early 2000s, we witnessed tremendous interest in venture capital in the past few years. Billions of dollars were directed into the industry, with 2020 reported as a record fundraising year.
With the United States being the biggest market for VC and creating the industry trends, the past several years have clearly been marked by a rising number of megafunds with $500m+ AUM and a decline in debut funds. I should say, though, that despite it being a global trend, we are still receiving requests from fund managers who are willing to set up their debut funds sized $50-100m and need help with the structuring of such funds and reviewing jurisdictions for proper set up.
Clearly, things have changed with current market volatility and geopolitical uncertainty. However, some fund managers are staying optimistic and confident that this structure may be a once-in-a-lifetime opportunity to enter the market, given depressed valuations and the possibility for smaller funds to get good deals and invest in truly outstanding companies.
What jurisdictions are usually recommended for venture funds?
International financial centers for fund formation, including venture capital funds, are well-known. They are the Cayman Islands, Guernsey, Jersey, Ireland, and Luxembourg jurisdictions, with Dubai, Hong Kong, and Singapore attracting interest too.
That being said, I would say that there is a lot of interest in the Cayman Islands. For top-tier investment funds, it has been a go-to jurisdiction for decades. Its proximity to the US, stable political regime, the fund legislation developed over the years with some of the most sophisticated structures being established there, and, lastly, enactment of the Private Funds law along with tax neutrality may be listed among the reasons to choose the Cayman Islands.
Can you elaborate on the Private Funds law?
The Law went into effect on February 7, 2020. It was introduced to bring the best world practices in private funds legislation to the Cayman Islands and to fill possible gaps in the regulation of private funds. Enactment of the Law also supports fund managers who are willing to approach European and Middle Eastern investors who tend to lean towards more regulated markets, like Guernsey.
The Law, in general, applies to any private fund, including a company, a unit trust, or a partnership that offers or issues or has issued investment interests with the purpose of pooling investor funds to enable investors to receive profits or gains from such entity’s acquisition, holding, management or disposal of investments. In this case, holders of investment interests have no day-to-day control over the acquisition, holding, management or disposal of the investments; the investments are managed as a whole by or on behalf of the operator of the private fund, directly or indirectly.
Here, “investment interest” means a share, an LLC interest, a trust unit or a partnership interest that carries an entitlement to participate in the profits or gains of the company, unit trust or partnership; and is not redeemable or re-purchasable at the option of the investor but does not include debt, or alternative financial instruments.
How can a fund be registered under the Law?
A private fund should submit an application for registration to the Cayman Islands Monetary Authority (CIMA) within twenty-one days of its acceptance of capital commitments from investors. The fund, or any person authorized to act on behalf of the fund, may engage in oral or written communication and enter into any agreements with high net worth or sophisticated persons interested in subscribing for or purchasing investment interests in the fund, prior to the filing of an application CIMA.
However, take note that a private fund that is to be registered can only accept capital contributions from investors in respect of investments after it is registered by CIMA. Also, when you are registered, there’s the prescribed annual registration fee which should be paid by the fund to the general revenue of the Cayman Islands on or before 15th January each year. Now the fee amounts to CI$3,500 (US 4,268.29).
Are there any other procedures that a registered fund is obliged to go through?
Yes, many. Accounts of the fund should be audited annually by an auditor approved by CIMA and submitted to CIMA each financial year within six months of the end of that financial year or within such extension of that period if allowed by CIMA. An annual return should be submitted to CIMA in the prescribed form each financial year as well.
Once a year there should be valuations of the fund’s assets performed by an independent third party, an administrator, the manager or operator of the private fund. Or a person who has a control relationship with the manager of the fund, provided that the valuation function is independent of the portfolio management function. In this case potential conflicts of interest should be properly identified, managed, monitored and disclosed to investors.
The fund should appoint a person to monitor its cash flows to ensure that all cash of the fund has been booked in cash accounts opened in its name or for its account and all payments made by investors to the fund in respect of investment interests have been received. Monitoring may be executed by an administrator, custodian or another independent third party, or the manager or operator. Again, if it’s the manager or operator, the cash monitoring function should be independent of the portfolio management function with all potential conflicts of interest identified and disclosed.
Also, a fund that regularly trades securities or holds them on a consistent basis should maintain a record of the identification codes of these securities and is obliged to make this record available to CIMA upon request.
What piece of advice would you give to those who want to register their fund within the Cayman Islands?
There are, of course, more nuances than the ones that I mentioned earlier. So, I highly recommend hiring a local consultant in the Cayman Islands to help you navigate through them. Apart from what we discussed above, there are more regulations regarding anti-money laundering, FATCA, etc. that should be considered by potential fund managers and a consultant can help you with these.