Many private equity funds have banks and other financial institutions as
significant limited partners – an arrangement that allows banks to gain access
to an important asset class for investing their assets, and provides anchor
funding to many private equity funds, especially “middle market” funds. The
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank)
implemented financial reforms including several limitations on how banks and
other financial institutions invest their capital.
Among these limitations are provisions collectively referred to as the
“Volcker Rule,” which relevantly provide that a bank or other financial
institution: (1) may not invest more than 3% of its Tier 1 capital into private
equity funds; and (2) cannot represent more than 3% of the total capital of a
given private equity fund.
Thus, for a $100 million private equity fund, any given bank could not commit
more than $3 million to that fund. Many private equity funds currently have
banks as anchor investors representing 20% or more of the fund’s capital.
Restricting each bank’s investment to 3% may leave a number of private equity
funds with significantly less capital to invest.
In addition, many banks are not equipped to process and manage investments
below a certain limit (for example, $10 million). For a $100 million fund, the
3% limitation would effectively preclude that fund from attracting capital from
such banks, because the fund would not be permitted to offer more than $3
million in commitments to any one bank.
Several aspects of the Volcker Rule are not clear in the statute or have been
explicitly left to be decided by the rulemaking process.
However, the Volcker Rule contains a clear and explicit reprieve from the
3% cap when banks invest in private equity funds that are licensed as small
business investment companies (SBIC Funds) by the U.S. Small Business Administration.
There are no limitations under the Volcker Rule on a bank’s investment in
SBIC Funds. For middle market private equity funds seeking capital commitments, a
license to operate as an SBIC could produce the tremendous advantage that banks
could continue to serve as anchor investors not subject to the Volcker Rule’s 3%
In addition, Dodd-Frank eliminates the exemption from SEC registration for
investment advisers to funds with fewer than 15 clients. However, among the
exceptions to this newly required registration is that an adviser to SBIC Funds need
not register with the SEC.
Private equity funds should consider the potential benefits of licensing by
SBA, as they develop fundraising plans and goals while contemplating the Volcker