SPECIAL: What the SEC's Private Funds Overhaul Means to Europe, with Owen Reynolds of Teklas Ventures

0:28This would never find it down. Welcome, everyone, to a very impromptu episode of the European VC. We are here today to talk about the new ruling by the SEC, the Securities and Exchange Council in the U.S. that is doing some very special things to the U.S. ecosystem, which, of course, is likely to also trickle into the European ecosystems rather soon. or will it? We'll see. With us today, we've got Owen Reynolds. He is our good friend with Techless Ventures, a family office based in Luxembourg. And first, before I'll allow Owen to dive into the ruling, I'll let Owen just tell us a bit about himself.

1:18Thanks so much for having me on today, Andreas. I really appreciate the chance to talk through this pretty interesting change to the ecosystem. And I'll start off with kind of what we do at TechLess and our background and where I'm coming from. So oddly enough, after being in the Peace Corps and getting started on my entrepreneurial journey there, I was actually an economist for a similar regulatory commission just around the corner from the SEC. So while I don't know exactly the way the SEC works on the inside, I think I've got like a good parallel view. And after that, went into went into VC investing first in impact investing in the US with a Midiar fund later, spent the last few years building up several funds at X-Bond Capital also in Luxembourg.

2:04And at Techless Ventures, we invest in industrial tech with a center around robotics and automation as well as automotive. But we cover a lot of the industry 4.0 sectors. Let me just come in here and then say, okay, so to everyone, you can hear Owen, background in VC, background also in the States. So, of course, also eyes, you know, in that direction. I think many of you will have listened and seen the news come out today and also seeing others right up to this ruling that this is going to be interesting to follow. Of course, the ruling is impacting funds because it has to do with how how funds manage their relationship to their LPs and specifically the information that they must give to their LPs.

2:57Maybe, Owen, you could just start here and tell us, you know, super down to earth, to basics for anyone listening in, the well-versed VC or well-versed LP that'll understand everything and find this. I've heard this a million times. I already know this. and to the ones that, you know, this comes as a bit of, okay, why is this important? Could you just give us the basics there? Yeah, for sure. So to start off with, the SEC, so the Securities and Exchange Commission in the U.S. is the agency that manages or regulates the financial markets. So that includes public markets traditionally, securities being the name, but it also includes private markets, which have been to date pretty lightly regulated.

3:42That said, of course, the private markets have probably tripled over the last decade. So they would probably be asleep at the wheel if they weren't increasing some sort of regulatory oversight on this or one of the agencies that's associated wasn't doing it. In terms of what this is changing, you hit the nail on the head. The pretty complex GP-LP relationships between general partners, which are the managers and investors directly into portfolio assets, whether it's real estate, venture capital, private equity, portfolio companies, and the LPs, which are these big capital providers. Think pension funds or insurance endowments in the U.S.

4:22is a big one, as well as family offices on both sides of the pond. And what this does is take, let's say, the plain vanilla structure of public markets, which basically is largely common shares. And there's only one rule and everyone is within the same pool of equity and kind of pour some of that onto the private markets. Not necessarily in terms of share class yet, but make some of that same kind of plain vanilla, easy to understand, easy for retail investors to get involved with. And in terms of the different parts, there's a lot of different things that come up in this ruling. So it's not a single rule.

5:01It's like, I think, eight different or nine different parts. And each different rule set has a whole series of categories. There's like 666 pages. But the majority of them look super no-brainer. There's quarterly statements, private fund audits, books and records, compliance. All these things are pretty much a low bar for even medium-sized funds. And only the smallest funds would ever say that they couldn't or don't have the man or woman power to fulfill those pretty simple obligations. And I think most being both a GP and LP at a family office, I can say that that's what we're always looking for.

5:41And we would seriously question ourselves if we were seriously looking at a fund that that wasn't doing these sorts of things. But then there's a bunch of other things kind of in between all of those lines where you're like, all right, quarterly statements, no brainer, fund audit, no brainer. And they're kind of difficult to know what they might mean if you don't dive in or aren't like flagging them. So there's this thing called prohibited activities and another called preferential treatment. And both of them are two key areas. If anyone follows the link and like digs into this, those are the two key areas to look at, as well as second advisor led secondaries.

6:16All of those things, though, change the dynamics between that GP and LP relationship. And for context, I mean, Andreas, you, like most of the listeners, know out better than I even do that the decades of private market transactions and the kind of light regulation, both in the US and in Europe, have led to a pretty complex set of negotiations at every closing. So we've often got a lot of different interests or a lot of different elements that we're negotiating for. It's not just share price. It's not just company valuation. It's all these sorts of other things. Starts with ESOPs, potential dilution, goes into the waterfall.

6:58How does each capital layer kind of end up? All of those things are also in public markets. But then there's even other things like information rights and a host of other pretty important things that come up in every term sheet and every shareholder's agreement for private market transactions that have no place in the public markets. And all of those have created this like weird stack of things that every LP and every GP are negotiating during those final days towards the transaction. and oftentimes they're being negotiated until the day of the transaction or like a week before if things are really clear and simple and what they do allow currently is it allows a GP and an LP to kind of stack their intentions and stack what's important to them individually and then negotiate that out and if the deal gets done then in theory both of them are happy if not then then you know they weren't able to get their interests aligned.

7:53But it does add a lot of flexibility. And from especially an early or emerging GP's perspective, this is the way to get deals done. You can make concessions or provide insights to LPs that they might not otherwise get and make promises, no matter how expensive or time consuming they might be for you as a GP. If you're a first-time fund manager or a second or even third-time manager, you might have to do these sorts of things to get deals done. And on the underlying portfolio company side, we see this all the time. To get a deal done, to get everyone happy, there's often these little add-on components.

8:30For the majority of them, they're not harmful to a transaction. That said, occasionally there are things. And just to pitch in there, this is obviously something that we also have seen in the LP ecosystem. Anyone thinking about investing in a fund will always be like, what are the site letters that are actually being done during this transaction and so on. Could you share a bit more light there, Owen, on both what you would normally as a family office expect and what you notoriously or always are wary of might be happening that you don't know about? Yeah. So the sign letters are notoriously untransparent.

9:15So most of the time, You have no idea what these other side letters are. You can ask if there's any. And what we usually do is ask if there are any that would have any implications on the economics. In terms of information rights, generally, we don't care. We hope that the performance beats out any informational arbitrage that we might face from from, you know, lacking or lagging in terms of information rights. But we do want to make sure that there is not part of the waterfall at the end of in distribution that we're not understanding. And that's really the most critical part from an economics perspective.

9:49So that's one side. But as a broader, like a bigger fund ecosystem, the LP ecosystem, there are often gaps created by even the highest performing funds, which can be large funds too. And they're often not incentivized to share all the information partially because that does get filtered through the LP's regulatory requirement filings. And those become quite visible to things like PitchBook and PreQuil. And all of a sudden, all that data that you might not want out to the public becomes pretty public every quarter. So that might be one reason for not publishing everything. But the majority of LPs do get the majority of information.

10:36And the odd thing about this ruling is that if you think about that bulk, that majority of LP investors, the vast majority are quite sophisticated. They have multi-person teams that have been doing this for decades that have a deep understanding of how to optimize stacking these different elements that you're negotiating for and coming out with a great outcome for their fund. What we don't talk about is who's going to be at the margin here. And the SEC, I believe, is probably making this ruling based on that marginal so-called retail investor. The retail investor is probably smaller family funds or high net worth individuals or maybe other funds that haven't really dived deep into the venture capital and private equity or hedge fund space, all of which are part of this ruling.

11:31And those are the funds that, let's say, on average may have less sophistication in terms of the way that they're looking at VC and private equity and hedge fund and real estate and that whole private market bundle. And if that's the case, then making this kind of plain vanilla set of things to be looking for does make it easier. However, there's a couple of risks that I think are interesting to think about when we're looking at how this is actually going to be implemented. The one that is obvious is that LPs will get more power. They get more information. They get more power. That's on bulk probably a good thing.

12:11The majority of them are, at least in the U.S., is representing pension funds, endowments. And in Europe, that's a slightly different mix. So you can probably tell where that kind of a similar regulation would lead on European insurers. Another is because it does require funds to, especially earlier funds, to have more regulatory compliance, including an annual compliance report, all those things take time. And time is money. And what that ends up meaning is it will be harder for small GPs to get going. Maybe at some point there will be thresholds above which these apply, but in the current ruling, that didn't seem to be the case.

12:57And that means lower democratization of GP formation. Yeah, I was just about to say, and in the article that we're publishing on EU.bc on this as well, you're pointing out another reason to also see lower democratization, which is, of course, that once you don't have these levers of, you know, different things that you can negotiate on, then all of a sudden, it's going to be harder for an LP to justify that bet that might be considered extra risky. do pitch in your own works here and also draw on your own thinking as an LP with a checklist. Totally. And that's exactly where I think the way this plays out will be really interesting.

13:40We don't know yet. And frankly, this will probably go to the courts a dozen times before we even know how this actually plays out, as is Anglo-Saxon law, the wonders of Anglo-Saxon law. But it does seem that it would add an extra burden to GP formation, add an extra burden to GP operations. And just like you said, if you take away some of these, some of this negotiating flexibility, it means that LPs will probably prefer to invest in large GPs that are able to entirely fulfill the structure easily and confidently, which means that you're concentrating GP capital into the few funds that are able to do that.

14:27not the few, but above a certain threshold, everyone has the person power to be able to do this. And how that kind of trickles down then to the most important part, the drivers of all the innovation and all of the value in the tech ecosystem is how it changes the entrepreneurial calculus. So if you imagine GPs become bigger, and this is still an F, again, these things may play out differently. But if you imagine GPs become more concentrated and LPs are putting more pressure on those same GPs for returns, those GPs are going to have to find ways to elicit returns. And they'll probably put pressure more on those middling outcome type companies.

15:10The big successes will be big successes. The power dynamics there will not change. But on the middle to low income or middle to low exit scenario type companies, we may see more GP influence on terms, less likelihood of doing deals if they aren't able to kind of get that extra percentage at the end. And that changes the calculus ultimately of how an entrepreneur is going to start a company. If the middle scenario becomes less likely or is even uncertain until these regulations start playing out, we may see an impact on the overall innovative environment. Now, as a former economist, I'll also say I love the idea that this makes things simpler.

15:54The regulation does aim to make all of these transactions less complicated, less complex, less time-extensive. And that means, in theory, increased macroeconomic efficiency. But that doesn't always mean that it is to the benefit of the ecosystem, to the benefit of a liquid market in terms of LPs and GPs being able to find the perfect match, and ultimately in terms of GPs being able to find the undiscovered talent that we need to do on a daily basis. This was, when you think of it as a whole, a very U.S.-centric conversation in the sense that this is an SEC ruling and it all goes for U.S. funds.

16:41I think in the written piece that we have going with this, you also state very clearly that there's two ways in which this can trickle over to Europe. One is that you'll see that, you know, LPs in the U.S. getting more used to that. So even if European lawmakers do not take over the whole rule set and implement the same type of rules here, we will see a pressure from the U.S. LPs demanding it and also maybe European LPs getting used to the U.S. being compliant here and for that reason expecting the same thing from the European managers. And then at the same time, I think you have a great quote in the article stating that, you know, you've never seen European regulators be outregulated.

17:38I don't want to put it past them, but I think it's important to know what the mandate is. And before getting into where I think that trickle through, I think you highlighted where I see that trickle through likely to happen, is to compare the mandate that the SEC specifically has. Their mandate is specifically investor protection, whatever the investor is. That doesn't always mean that that is to the benefit of society. And I pointed out one great video that I saw in a recent documentary that has two agriculture regulators kind of squabbling about their mandate. their mandate. And there are limits to that mandate.

18:17I can tell you from being on that side of the table, you have to point in the same direction. And if the regulation you're building is pointing towards your mandate, then it's good. If it points in an outside direction, A, it isn't going to get passed at the commission. And you could get sued by either the industry or even lawmakers themselves. So there's a pretty fine area that each of these commissions has to work in. And the SEC is investor protection. So again, that doesn't necessarily mean that they're focused on GP formation, they're worried about capital formation. And that probably means the amount of capital raised in the ecosystem as opposed to the amount and democratization of GPs themselves, which on a whole may be less capital efficient, but may be more efficient for entrepreneurs to access in the end.

19:07So going back to your point about what does this mean to Europe? And at the moment, very little, again, until we start to see this like trickle through. But you hit the nail on the head where because U.S. capital providers, especially at a later stage, are often an important part of a capital stack, and you want to have the capital stack before that kind of harmonious with what you're expecting at a later stage, we could see European investors start to kind of sync with it even before there's any regulation or any clarity with what these rules mean. And yeah, I'm not sure if there is any interest in Brussels to do something similar.

19:55But I would encourage, if there's any future regulation, to kind of think about what the mandates in the U.S. mean and where that differs from the LP base that we have in Europe versus the LP base in the U.S., as well as what that mandate directly means for U.S. investors versus what the European regulators would be aiming to do here on this side of the pond. You know, just to wrap this up, I think that you said something interesting at some point in this conversation where you said that this is likely or potentially because they're looking out for a new class of investors in this space, which is the private investors or retail investors that have kind of, you know, you've seen U.S.

20:45law becoming more open to allowing GPLP structures to take more retail money and be marketed more openly. You know, so in that sense, at least from my perspective, this might be a pointer in the direction of something interesting coming because you have to make sure that you've got a, you know, tight ship before you allow retail investors to come in. I don't want to let you speculate or ask you to speculate on that one because I think it's both beyond your purview and mine. I just think that I am a bit more just saying whatever the fuck I want so for that reason I'm putting that out there and saying that let's hope that that's what this is a harping of and except for that I would just say thanks a million for writing this piece and putting it out on EU.BC and coming and joining us here to have this conversation yeah for sure thanks so much for taking the chance to look at this and we'll talk again soon

21:48Tear down this wall. It's more than just an alliance. This is a union of values. United and determined we can serve as a model for other regions of the world. The nature of a problem requires a European response. Europe is a story of new beginnings. Let's start acting.