Venture Capital Operations and Regulation
link to page 1 
May 25, 2023
Venture Capital Operations and Regulation
Venture capital (VC) funds are sources of startup financing
Seed stage. During the seed stage, startups have developed
for early-stage, high-growth firms, such as technology
initial business operations, including operational readiness
startups. According to the Securities and Exchange
for products or product prototypes. But the business
Commission (SEC), as of the second quarter of 2022, more
typically remains pre-revenue. Early VC, SFF, and angel
than 2,000 VC funds were managing about $330 billion in
investors are common sources of funding at this stage.
assets. Although the size of VC investments appears small
compared to the overall size of U.S. capital markets (which
Series A. This is generally the first round where VC
exceeds $100 trillion) the industry nonetheless plays a key
becomes the dominant source of funding. A startup at this
role in funding entrepreneurs that carry out innovations.
stage has generally developed marketable products and a
These startups form the pipeline for potentially
customer base. This is also the stage when startups have
transformative companies that could become drivers of
developed their business plans and started to proactively
economic growth. Many well-known publicly traded
approach different institutional investors for fundraising.
technology companies—such as Alphabet (Google’s parent
company), Apple, Meta, and Amazon—were once VC
Series B. During a Series B funding round, VC investors
funded. This In Focus explains VC operations, regulatory
usually focus on the acceleration of business expansion and
frameworks, and policy proposals.
commercialization of the products. Series B round startups
are relatively established and have begun to achieve more
Startup Funding Cycle
substantial performance milestones.
Figure 1 illustrates the typical stages of a startup funding
cycle. VC funds could participate in all stages of a cycle but
Series C. Late-stage VC and other institutional investors
generally focus on earlier to middle stages. Depending on a
(including private equity firms, investment banks, and
startup’s specific development phase, the firm’s funding
hedge funds) provide series C funding to more mature
needs and financing sources could differ. A startup’s
companies. Series C funding helps startups to further
development stage is typically measured by revenue
expand their products and markets. A startup at this stage
growth, time in existence, and product maturity, among
has ordinarily demonstrated strong growth, a trajectory
other factors. In general, the later the stage, the larger the
toward profitability, and a customer base.
startup’s size and funding needs.
Mezzanine. This is the last stage of VC involvement before
Figure 1. Startup Funding Cycle
a final exit to sell their investment positions for cash.
Startups at this stage have matured and are ready to be
acquired or become publicly traded.
Exit. Most VCs aspire to exit their investments via initial
public offerings (IPOs). At this stage, the startup could
issue securities to the public. But other forms of exit also
exist, including sales to other corporations or private funds.
A startup could also merge with a special purpose
acquisition company (see CRS In Focus IF11655, SPAC
IPO: Background and Policy Issues) at this stage.
Business Models and Practices
VC investors assume high risks in the hopes of making high
Source: CRS.
returns. VC firms often have several dozen startup
Notes: A stylized graphical depiction of a startup funding cycle and
companies in their portfolios and are actively involved in
startup company growth line.
their operations. While some of these portfolio companies
may fail, VC investors can still reap substantial rewards if
Pre-seed stage. At this early stage, the startup has gone
some surviving portfolio companies achieve major success
through concept formation but has typically not yet
(e.g., receive 5, 10, or 20 times the initial investment). VCs
commenced business operations or sold products. “Self,
have varying levels of size, expertise, and depth of financial
family, and friends” (SFF, also called “bootstrapping”) and
strength. Different VCs may show different preferences for
angel investors (e.g., accredited investors, see CRS In
a particular industry segment or startup development stage.
Focus IF11278, Accredited Investor Definition and Private
VCs are often associated with high innovation and
Securities Markets) typically provide major sources of
performance. An academic study of IPOs, shows that VC-
funding.
backed IPOs outperformed other IPOs in key financial
https://crsreports.congress.gov
link to page 2 Venture Capital Operations and Regulation
measures (Table 1). However, VC firms and VC-backed
To be exempt from ICA, a VC fund must also be owned by
companies are highly concentrated in three metropolitan
250 or fewer persons and must have $10 million or less in
areas—the San Francisco Bay Area, New York, and
aggregate capital contributions and uncalled committed
Boston. VC investments are also concentrated in certain
capital (i.e., capital not yet disbursed). Qualifying VC funds
are exempt from the ICA and are not required to register
relatively narrow technological innovations.
with the SEC and provide related disclosure and
compliance at the fund level. In addition, VC funds may use
Table 1. Relative Performance of VC-Backed IPOs
other exemptions that are not limited to VC funds
(1995-2019)
specifically but could also provide exemption to registration
under the ICA. For example, under Sections 3(c)(1) and
VC-
VC-
All
3(c)(7) of the ICA, funds are exempt from ICA if they meet
Backed
Backed as
IPOs
certain requirements, such as ownership and purchaser
IPOs
a % of All
restrictions.
Total number of non-
VC Adviser Regulation
1,930
4,109
47.0%
financial IPOs (1995-2019)
Investment advisers, including VC advisers, could be
subject to regulation prescribed in the Investment Advisers
Number of firms stil public
582
1,044
55.7%
Act of 1940 (IAA; P.L. 76-768). Section 202(a)(11) of the
at 12/31/2019
IAA defines adviser as any person or firm that, for
Share of IPOs that were
compensation, is engaged in providing advice to others or
30%
25%
stil public at 12/31/2019
issuing reports or analyses regarding securities. VC fund
managers could qualify as advisers and be subject to related
Total enterprise value
$4,845
$7,130
67.9%
SEC registration and oversight or seek exemption from
($bil ions)
registration. Rule 203(I) of the IAA provides an exemption
Total market capitalization
for VC advisers who are solely advising VC funds. These
$4,922
$6,462
76.2%
advisers are considered exempt reporting advisers (ERAs).
($bil ions)
ERAs are not subject to the same federal or state
Research and development
registration procedures as other SEC-registered investment
$148
$167
88.6%
expenditure ($bil ions)
advisers but must still register with and report to securities
regulators and satisfy certain compliance requirements. For
Source: Josh Lerner and Ramana Nanda, “Venture Capital’s Role in
example, ERAs must file parts of Form ADV with the SEC
Financing Innovation: What We Know and How Much We Stil Need
and state securities authorities. These Form ADV
to Learn,” NBER, July 2020, https://www.nber.org/papers/w27492.
disclosures are publicly available, including information
Regulatory Frameworks
about the adviser’s business, ownership, employees,
affiliations, fund size, and past disciplinary events, among
While VC funds and VC advisers are generally subject to
other information. Similar to other registered investment
regulations applicable to investment funds and advisers,
advisers, ERAs must also meet other compliance
they can qualify for exemptions by meeting various criteria.
requirements, including fiduciary, anti-fraud, anti-money
VC Fund Regulation Exemptions
laundering, and investor privacy protection requirements.
In general, funds that invest in businesses on behalf of the
Policy Proposals
funds’ investors face regulation pursuant to the Investment
Some legislative proposals aim to expand capital formation
Company Act of 1940 (ICA; P.L. 76-768). However,
under VC funds by expanding the related legal definitions
pursuant to the Dodd-Frank Wall Street Reform and
that provide exemptions. The Developing and Empowering
Consumer Protection Act (P.L. 111-203), the SEC
our Aspiring Leaders Act of 2023 (H.R. 2579) proposes to
established a legal definition for venture capital funds for
change the definition of QIs to include certain secondary
the first time in 2011 and established exemptions from
transactions and fund of funds. The proposal would address
certain ICA regulatory requirements. To be deemed venture
the concern that VC funds are increasingly challenged by
capital and receive related exemptions, the fund must
the 20% limit of non-qualifying investments. Some VC
generally meet the following conditions: (1) represents
advocates argue that the limit often causes VCs to forgo
itself as pursuing a venture capital strategy to its investors
general investment opportunities. But some investor
and prospective investors; (2) holds no more than 20% of
advocates are concerned that by permitting an expanded VC
its aggregate capital contributions and uncalled committed
fund investment presence in secondary market shares, VCs
capital in non-qualifying investments other than short-term
could shift fund activity away from direct primary
holdings; (3) does not borrow, provide guarantees, or
investment stakes in startups. The Improving Capital
otherwise incur leverage other than limited short-term
Allocation for Newcomers Act of 2021 (H.R. 2790)
borrowing; (4) does not offer its investors redemption or
proposes to raise the persons and committed capital
other similar liquidity rights except in extraordinary
thresholds for VC qualification requirements, thus
circumstances; and (5) is not registered under the ICA and
increasing the number of funds that could potentially use
has not elected to be treated as a business development
the VC exemption. Title III and Title VI of the Expanding
company. Qualifying investments (QIs) generally consist of
Access to Capital Act of 2023 (H.R. 2799) also contain
direct equity investments in qualifying portfolio companies.
related VC proposals.
Secondary transactions (i.e., the selling of existing shares),
fund of funds (i.e., a fund that invests in other funds), pure
Eva Su, Specialist in Financial Economics
debt instruments, public issuance, and some digital assets
IF12412
are generally not QIs.
https://crsreports.congress.gov
Venture Capital Operations and Regulation
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.
https://crsreports.congress.gov | IF12412 · VERSION 1 · NEW
May 25, 2023
Venture Capital Operations and Regulation
Venture capital (VC) funds are sources of startup financing
Seed stage. During the seed stage, startups have developed
for early-stage, high-growth firms, such as technology
initial business operations, including operational readiness
startups. According to the Securities and Exchange
for products or product prototypes. But the business
Commission (SEC), as of the second quarter of 2022, more
typically remains pre-revenue. Early VC, SFF, and angel
than 2,000 VC funds were managing about $330 billion in
investors are common sources of funding at this stage.
assets. Although the size of VC investments appears small
compared to the overall size of U.S. capital markets (which
Series A. This is generally the first round where VC
exceeds $100 trillion) the industry nonetheless plays a key
becomes the dominant source of funding. A startup at this
role in funding entrepreneurs that carry out innovations.
stage has generally developed marketable products and a
These startups form the pipeline for potentially
customer base. This is also the stage when startups have
transformative companies that could become drivers of
developed their business plans and started to proactively
economic growth. Many well-known publicly traded
approach different institutional investors for fundraising.
technology companies—such as Alphabet (Google’s parent
company), Apple, Meta, and Amazon—were once VC
Series B. During a Series B funding round, VC investors
funded. This In Focus explains VC operations, regulatory
usually focus on the acceleration of business expansion and
frameworks, and policy proposals.
commercialization of the products. Series B round startups
are relatively established and have begun to achieve more
Startup Funding Cycle
substantial performance milestones.
Figure 1 illustrates the typical stages of a startup funding
cycle. VC funds could participate in all stages of a cycle but
Series C. Late-stage VC and other institutional investors
generally focus on earlier to middle stages. Depending on a
(including private equity firms, investment banks, and
startup’s specific development phase, the firm’s funding
hedge funds) provide series C funding to more mature
needs and financing sources could differ. A startup’s
companies. Series C funding helps startups to further
development stage is typically measured by revenue
expand their products and markets. A startup at this stage
growth, time in existence, and product maturity, among
has ordinarily demonstrated strong growth, a trajectory
other factors. In general, the later the stage, the larger the
toward profitability, and a customer base.
startup’s size and funding needs.
Mezzanine. This is the last stage of VC involvement before
Figure 1. Startup Funding Cycle
a final exit to sell their investment positions for cash.
Startups at this stage have matured and are ready to be
acquired or become publicly traded.
Exit. Most VCs aspire to exit their investments via initial
public offerings (IPOs). At this stage, the startup could
issue securities to the public. But other forms of exit also
exist, including sales to other corporations or private funds.
A startup could also merge with a special purpose
acquisition company (see CRS In Focus IF11655, SPAC
IPO: Background and Policy Issues) at this stage.
Business Models and Practices
VC investors assume high risks in the hopes of making high
Source: CRS.
returns. VC firms often have several dozen startup
Notes: A stylized graphical depiction of a startup funding cycle and
companies in their portfolios and are actively involved in
startup company growth line.
their operations. While some of these portfolio companies
may fail, VC investors can still reap substantial rewards if
Pre-seed stage. At this early stage, the startup has gone
some surviving portfolio companies achieve major success
through concept formation but has typically not yet
(e.g., receive 5, 10, or 20 times the initial investment). VCs
commenced business operations or sold products. “Self,
have varying levels of size, expertise, and depth of financial
family, and friends” (SFF, also called “bootstrapping”) and
strength. Different VCs may show different preferences for
angel investors (e.g., accredited investors, see CRS In
a particular industry segment or startup development stage.
Focus IF11278, Accredited Investor Definition and Private
VCs are often associated with high innovation and
Securities Markets) typically provide major sources of
performance. An academic study of IPOs, shows that VC-
funding.
backed IPOs outperformed other IPOs in key financial
https://crsreports.congress.gov
link to page 2 Venture Capital Operations and Regulation
measures (Table 1). However, VC firms and VC-backed
To be exempt from ICA, a VC fund must also be owned by
companies are highly concentrated in three metropolitan
250 or fewer persons and must have $10 million or less in
areas—the San Francisco Bay Area, New York, and
aggregate capital contributions and uncalled committed
Boston. VC investments are also concentrated in certain
capital (i.e., capital not yet disbursed). Qualifying VC funds
are exempt from the ICA and are not required to register
relatively narrow technological innovations.
with the SEC and provide related disclosure and
compliance at the fund level. In addition, VC funds may use
Table 1. Relative Performance of VC-Backed IPOs
other exemptions that are not limited to VC funds
(1995-2019)
specifically but could also provide exemption to registration
under the ICA. For example, under Sections 3(c)(1) and
VC-
VC-
All
3(c)(7) of the ICA, funds are exempt from ICA if they meet
Backed
Backed as
IPOs
certain requirements, such as ownership and purchaser
IPOs
a % of All
restrictions.
Total number of non-
VC Adviser Regulation
1,930
4,109
47.0%
financial IPOs (1995-2019)
Investment advisers, including VC advisers, could be
subject to regulation prescribed in the Investment Advisers
Number of firms stil public
582
1,044
55.7%
Act of 1940 (IAA; P.L. 76-768). Section 202(a)(11) of the
at 12/31/2019
IAA defines adviser as any person or firm that, for
Share of IPOs that were
compensation, is engaged in providing advice to others or
30%
25%
stil public at 12/31/2019
issuing reports or analyses regarding securities. VC fund
managers could qualify as advisers and be subject to related
Total enterprise value
$4,845
$7,130
67.9%
SEC registration and oversight or seek exemption from
($bil ions)
registration. Rule 203(I) of the IAA provides an exemption
Total market capitalization
for VC advisers who are solely advising VC funds. These
$4,922
$6,462
76.2%
advisers are considered exempt reporting advisers (ERAs).
($bil ions)
ERAs are not subject to the same federal or state
Research and development
registration procedures as other SEC-registered investment
$148
$167
88.6%
expenditure ($bil ions)
advisers but must still register with and report to securities
regulators and satisfy certain compliance requirements. For
Source: Josh Lerner and Ramana Nanda, “Venture Capital’s Role in
example, ERAs must file parts of Form ADV with the SEC
Financing Innovation: What We Know and How Much We Stil Need
and state securities authorities. These Form ADV
to Learn,” NBER, July 2020, https://www.nber.org/papers/w27492.
disclosures are publicly available, including information
Regulatory Frameworks
about the adviser’s business, ownership, employees,
affiliations, fund size, and past disciplinary events, among
While VC funds and VC advisers are generally subject to
other information. Similar to other registered investment
regulations applicable to investment funds and advisers,
advisers, ERAs must also meet other compliance
they can qualify for exemptions by meeting various criteria.
requirements, including fiduciary, anti-fraud, anti-money
VC Fund Regulation Exemptions
laundering, and investor privacy protection requirements.
In general, funds that invest in businesses on behalf of the
Policy Proposals
funds’ investors face regulation pursuant to the Investment
Some legislative proposals aim to expand capital formation
Company Act of 1940 (ICA; P.L. 76-768). However,
under VC funds by expanding the related legal definitions
pursuant to the Dodd-Frank Wall Street Reform and
that provide exemptions. The Developing and Empowering
Consumer Protection Act (P.L. 111-203), the SEC
our Aspiring Leaders Act of 2023 (H.R. 2579) proposes to
established a legal definition for venture capital funds for
change the definition of QIs to include certain secondary
the first time in 2011 and established exemptions from
transactions and fund of funds. The proposal would address
certain ICA regulatory requirements. To be deemed venture
the concern that VC funds are increasingly challenged by
capital and receive related exemptions, the fund must
the 20% limit of non-qualifying investments. Some VC
generally meet the following conditions: (1) represents
advocates argue that the limit often causes VCs to forgo
itself as pursuing a venture capital strategy to its investors
general investment opportunities. But some investor
and prospective investors; (2) holds no more than 20% of
advocates are concerned that by permitting an expanded VC
its aggregate capital contributions and uncalled committed
fund investment presence in secondary market shares, VCs
capital in non-qualifying investments other than short-term
could shift fund activity away from direct primary
holdings; (3) does not borrow, provide guarantees, or
investment stakes in startups. The Improving Capital
otherwise incur leverage other than limited short-term
Allocation for Newcomers Act of 2021 (H.R. 2790)
borrowing; (4) does not offer its investors redemption or
proposes to raise the persons and committed capital
other similar liquidity rights except in extraordinary
thresholds for VC qualification requirements, thus
circumstances; and (5) is not registered under the ICA and
increasing the number of funds that could potentially use
has not elected to be treated as a business development
the VC exemption. Title III and Title VI of the Expanding
company. Qualifying investments (QIs) generally consist of
Access to Capital Act of 2023 (H.R. 2799) also contain
direct equity investments in qualifying portfolio companies.
related VC proposals.
Secondary transactions (i.e., the selling of existing shares),
fund of funds (i.e., a fund that invests in other funds), pure
Eva Su, Specialist in Financial Economics
debt instruments, public issuance, and some digital assets
IF12412
are generally not QIs.
https://crsreports.congress.gov
Venture Capital Operations and Regulation
Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.
https://crsreports.congress.gov | IF12412 · VERSION 1 · NEW