In the competitive landscape of fund management, raising capital is paramount for success. Regulatory frameworks play a crucial role in facilitating fundraising efforts, providing avenues for fund managers to reach a broader investor base, without being hindered by bureaucratic notification processes. Among these frameworks, the “passporting” regime stands out, facilitating a streamlined cross-border marketing within the European Union (the “EU”).

Two widely recognised regulatory frameworks that support the concept of “passporting”, are:

1. The Alternative Investment Fund Managers Directive (“AIFMD”), which enables AIFMs to market and manage funds across EU member states, simplifying the process for targeting professional investors; and
2. The European Venture Capital (“EuVECA”) Regulation, which offers a promising solution for authorized or registered AIFMs seeking to maximize their capital raising endeavors within the EU.

This article explores how Alternative Investment Fund Managers (“AIFMs”) established in Cyprus can benefit from the EuVECA labeling and maximize their capital raising efforts.

1. Advantages for Cyprus AIFMs under the AIFMD

Cyprus AIFMs can benefit significantly from the “passporting” regime introduced by the AIFMD and transposed into local legislation through the Alternative Investment Fund Managers Law 56(I)/2013. This regime allows Cyprus AIFMs to freely market the units of their managed Alternative Investment Funds (“AIFs”) or Registered AIFs (“RAIFs”) to professional investors across the EU, following a proper notification to the Cyprus Securities and Exchange Commission (“CySEC”) and other subsequent actions.

2. Navigating the Challenges with Well-Informed Investors

Should an AIFM wish to establish and operate a Cyprus based AIF or RAIF, they can do so based on the provisions of the Alternative Investment Funds Law 124(I)/2018 (the “AIF Law”). A notable feature of the AIF Law is the inclusion of an additional category of investors known as the "well-informed." This category encompasses investors who are not professional and must meet certain criteria to qualify, such as confirming in writing about their financial and business experience and understanding of inherent risks, as well as typically investing a minimum of EUR 125,000 or its currency equivalent.

Practice shows that most Cyprus AIFMs focus their fundraising efforts on attracting high-net-worth individuals or financial entities qualifying under the well-informed investor category. These investors, often possessing substantial financial resources and a keen understanding of investment risks, are sought after for their potential to contribute significant capital to alternative investments, including venture capital. However, this investor category does not benefit from the passporting regime established by the AIFMD. As a result, external managers of AIFs and RAIFs that rely solely on capital raising from well-informed investors may face limitations in their ability to market their units across other EU member states.

Navigating the regulatory complexities associated with targeting well-informed investors requires careful attention. A Cyprus AIFM would have to ensure compliance with the marketing procedures mandated by the legislation of the host EU Member State. This entails receiving a relevant confirmation from the competent authorities of that EU Member State with regards to marketing in that jurisdiction, a process that can involve material cost and time.

To mitigate the limitations posed by the exclusion of “well-informed” investors from the passporting regime, Cyprus AIFMs may explore strategies to diversify their investor base. This might involve targeting other investor categories eligible for passporting or seeking alternative avenues for cross-border fundraising and investment management.

3. How Fund Managers Can Benefit from the Passporting Regime of the EuVECA

Cyprus AIFMs pursuing venture capital investments can expand their “passporting” capabilities beyond professional investors through the EuVECA regulation. The EuVECA framework allows fund managers to freely market the units of their venture capital AIFs or RAIFs to “other investors” who commit to investing at least EUR 100,000 and acknowledge in writing the associated risks separately from any investment contract. As one can appreciate, this category of investors is very similar to the “well-informed” investor category.

If an AIFM benefits from passporting under the EuVECA regulation, it can market to a broader category of investors across the European Union, not just to professional clients but also to the so-called “other investors” who meet the minimum investment and awareness criteria.

This means that the "passporting" privileges extend to marketing to this broader investor base, provided the AIFM and the AIF/RAIF itself meet all the regulatory requirements of the EuVECA framework. This is a significant advantage as it simplifies the cross-border marketing and administrative processes for AIFMs looking to raise funds across the EU from a diverse investor base.

4. Procedure to Setup a EuVECA

As with any fund, establishing a EuVECA AIF or RAIF involves a structured process governed by regulatory requirements. Firstly, before setting up a EuVECA AIF or RAIF, a Cyprus AIFM should ensure that the eligibility criteria for the EuVECA license in terms of investment focus, limits and overall compliance must be met. A legal structure then has to be established, such as a limited partnership or a corporate entity, and authorization (or registration for a RAIF) needs to be gained from CySEC in accordance with the provisions of the AIF Law.

The application process entails the submission of an application (or registration for a RAIF) form to CySEC detailing the investment strategy, legal structure, and compliance measures. Additionally, it requires, amongst others, for the submission of the necessary fund documentation, such as the prospectus and constitutional documents, and paying the applicable fees.

The prospectus and constitutional documents will have to be upgraded to incorporate all EuVECA features and characteristics to ensure compliance with the requirements of the EuVECA license. This includes implementing appropriate investment objectives, risk management practices, investment and leverage limits, investor categories, and reporting obligations. Once authorized, the EuVECA label allows for the units of the AIF or a RAIF to be marketed across EU member states to professional and “other” investors, using the “passporting” regime, thus enhancing its fundraising potential and operational flexibility.

5. Understanding the EuVECA Restrictions

While having vast benefits, the nature of the EuVECA also brings certain restrictions and limitations, which, by design, ensure investor protection and focus on the Small to Medium Enterprises (“SMEs”). Despite the fact that this results in a balance between investor protection and the promotion of SME growth, it also causes certain hindrances.

For instance, EuVECA funds must comply with specific investment criteria and portfolio diversification requirements to qualify for the EuVECA label. Specifically,  EuVECA funds must primarily invest in equity or quasi-equity instruments, such as shares, partnership interests, or other instruments that provide risk capital to SMEs, and cannot be excessively exposed to a single SME or investment. This means that the investments may bear a higher risk, and may limit the fund’s liquidity and ability to exit, as venture capital equity is known for being risky and illiquid. While this indeed sets the fund a very specific remit, it ensures that venture capital funds do ‘what the label says’ and invest in venture capital, rather than using funds raised with the promise of investing in venture capital to merely invest in fixed income and get a steady return.

The EuVECA label was made for venture capital funds, and most of the restrictions mentioned above occur naturally for a venture capital fund, and hence, should not be seen as restrictions brought on by the label, but rather, guidance to fund managers on how to truly structure a venture capital fund. Through the adherence to the above restrictions, the EuVECA label is used as it was intended, in order to benefit both investors and SME’s, and protect the nature of venture capital. It is important to note that in the case of a Cyprus AIF, similar restrictions would anyway apply, as these derive from the CySEC Directive 131-2014-02 regarding the classification of the AIFs of the Republic and other relevant issues.

6. Epilogue

In conclusion, the EuVECA framework can offer an invaluable opportunity for Cyprus AIFMs to maximize their capital raising efforts within the EU. By leveraging the passporting regime and tapping into a broader investor base, a Cyprus AIFM can enhance its competitiveness and unlock new avenues for growth. As the landscape of venture capital continues to evolve, EuVECA remains a vital tool for fund managers navigating the complexities of fundraising in the EU.