Venture Capital Formation and Access: Lingering Impediments of the Investment Company Act of 1940

Abstract

Despite its acknowledged importance to the vitality of the American economy, venture capital remains governed by a patchwork regulatory structure. This regulatory labyrinth often proves onerous to capital formation and access to activities by entrepreneurs and investors, creating various artificial inefficiencies without advancing any justifiable legislative policy aim. The primary problem is that venture capital firms are not regulated based on their own unique identity, but rather are incidentally overseen by other securities and investment laws, the genesis of which derives from legislation in the 1930s and 1940s–a time far removed from the dynamic role venture capital has come to play in the modern American economy. The literature reflects the dissonant nature of venture capital regulation. The contractual nature of venture capital transactions along with the recent role of law firms in venture financing has received some attention. The discriminatory tax and shareholder implications of the regulatory framework overseeing venture capital activity also have been discussed. Finally, the failure of the business development company (“BDC”) program, one of many congressional attempts to enhance venture activity by publicizing it instead of deregulating it, has been examined. However, a complete analysis of the regulations the venture capitalist, entrepreneur, and average investor face in this area remains significantly absent from legal scholarship. This paper endeavors to fill this void in understanding the importance of venture capital, how it is regulated, and what public policy concerns may by implicated. As the reader will see, the regulatory oversight of venture capital is highly complicated, multi-layered, often a result of legislative objectives completely divorced from the actual operations of venture capital firms, and, despite purported reforms, still highly incoherent in nature. The reader also will see that the achievement of a more sensible system, in which market efficiencies are allowed to operate and all investors are allowed to have a diversified portfolio inclusive of venture capital investments, raises the most fundamental policy issues of the American system where a free market economy is juxtaposed by safeguards to protect the integrity of the markets.