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Private Equity, Venture Capital, and Hedge Funds

Getting Started

Introduction

Private equity, venture capital, and hedge funds are examples of alternative investments that have become increasingly popular since the mid-1990s. Compared to more traditional investments (e.g., stocks, bonds, cash, and mutual funds), alternative investments tend to be less liquid (i.e., more difficult to convert back to cash), more complicated, subject to fewer regulations, and often produce higher returns for investors. 

Please see the individual sections of this Guide for more information.

Private Equity (PE)

Introduction

Private equity (PE) is ownership of (or an interest in) an entity that is not publicly traded. Often, it is high net worth individuals and/or firms that purchase shares of privately-held companies or acquire control of publicly-traded companies (and possibly take a public company private). The aim is to invest in companies that have growth potential and then use the private equity investment to turnaround or expand the business. The company can then be sold for a profit. 

Private equity firms (also known as private equity funds) offer investment opportunities to a limited number of accredited investors (limited partners) who are better able to understand and financially handle the risks of such investments. These limited partners often consist of university endowment funds, pension funds, wealthy people, and other companies. (Private equity firms typically serve as the general partner.)

Primary Law

In the U.S., private equity (PE) funds are typically formed as limited partnerships in the State of Delaware, pursuant to the Delaware Revised Uniform Limited Partnership Act (DRULPA) (though the laws of other states may be used instead). Private equity funds are typically based on individual (private) contractual arrangements and therefore are exempt from the disclosure and other requirements applicable to publicly traded companies or investments, such as:

  • US Investment Advisers Act of 1940 (Advisers Act) — Regarding the registration of fund managers with the SEC.
  • Investment Company Act of 1940 — Regarding the management and operation of a "fund."
  • Securities Exchange Act of 1934 (Exchange Act) — Regarding the distribution of securities.
  • Securities Act  — Regarding the issuance of securities to the public.
  • "Blue Sky Laws" — A common term for state securities laws.

Unless exempt, PE funds may be subject to regulation by the following agencies:

  • Securities and Exchange Commission (SEC)
  • Financial Industry Regulatory Authority (FINRA)
  • US Commodity Futures Trading Commission (CFTC)

The tradition of light regulation for PE funds changed in 2010 with the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. § 5301 et seq.). More PE fund advisors are required to register with either the SEC or at the state level, resulting in increased recordkeeping obligations and the possibility of regulatory inspections.​

Secondary Sources

U.S. Resources:

International Resources:

Current Awareness

Below are some resources for private equity news and developments:

Databases and Other Resources

Venture Capital (VC)

Introduction

Venture capital (VC) is an important source of funding for new businesses (e.g., start-ups) that do not have access to other sources, such as business loans from banks or capital markets, but do have potential for long-term growth. Although these investments often involve high risk, they can also offer above-average returns. The VC investors often negotiate to obtain equity ownership, representation on the company's board of directors, and/or an active role in managing the company's operations.

Primary Law

Venture capital is a type of private equity investment (see "Private Equity," above) and historically, private equity investments have been lightly regulated. This changed in 2010 with the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. § 5301 et seq.). The Dodd-Frank Act:

  • Prohibited banks from using their own money (as opposed to customer deposits) to make certain investments, including private equity (known as the Volker Rule). This restriction generally prevents banks from serving as venture capital investment firms.
  • Required hedge fund managers and private equity fund managers to register their funds with the Securities and Exchange Commission (SEC), but not venture capital managers, provided at least 80% of their fund holdings are in "qualifying investments" (generally shares in private companies).

In 2012, the Jumpstart Our Business Startups Act (JOBS Act) (Pub. L. 112–06) relaxed many existing securities law requirements, including the advertising prohibition on venture capitalists and companies seeking private equity investments. 

Secondary Sources

Current Awareness

Below are some resources for venture capital news and developments:

Databases and Other Resources

Hedge Funds (HF)

Introduction

Hedge funds (HF) are a type of investment partnership where a number of investors (i.e., the limited partners) pool their funds together to be invested by a professional fund manager (i.e., the general partner) according to the fund's investment strategy — which may be innovative or otherwise nontraditional when compared to more familiar investment options. While structurally similar to a mutual fund, HFs generally invest more aggressively and are limited to "qualified" investors (i.e., those who meet certain net worth requirements, making them better able to tolerate the increased investment risk). Compared to the heavily regulated mutual funds, HFs operate with a wide degree of investment latitude and are often leveraged to maximize their returns.

HFs differ from private equity (PE) firms in that HFs usually focus on short or medium term liquid securities that are more quickly convertible to cash. HFs also do not have direct control over the business or asset in which they are investing. By contrast, PE firms are geared toward longer-term investment strategies in illiquid assets, where they have more control or influence over operations to influence the long-term returns.

Primary Law

U.S. hedge funds (HFs) have significant freedom in their investment activities because they are designed to be exempt from many of the registration and reporting requirements of the otherwise applicable securities laws, for example:

  • US Investment Advisers Act of 1940 (Advisers Act) — Regarding the registration of fund managers with the SEC.
  • Investment Company Act of 1940 — Regarding the management and operation of a "fund."
  • Securities Exchange Act of 1934 (Exchange Act) — Regarding the distribution of securities.
  • Securities Act  — Regarding the issuance of securities to the public.
  • "Blue Sky Laws" — A common term for state securities laws.

Unless exempt, HFs are subject to regulation by the following agencies:

  • Securities and Exchange Commission (SEC)
  • Financial Industry Regulatory Authority (FINRA)
  • US Commodity Futures Trading Commission (CFTC)

The tradition of light regulation for HFs changed in 2010 with the Dodd-Frank Wall Street Reform and Consumer Protection Act (12 U.S.C. § 5301 et seq.). More HF advisors are required to register with either the SEC or at the state level, resulting in increased recordkeeping obligations and the possibility of regulatory inspections.

For a summary of  U.S. hedge fund regulation, see The History of Hedge Fund Regulation in the United States, by Wulf A. Kaal and Dale A. Oesterle.

Secondary Sources

Current Awareness

Below are some resources for hedge fund news and developments:

Databases and Other Resources

Additional Resources

Additional Resources to Consider

Some other related resources to consider:

Legal research platforms also contain information on PE, VC, and HF matters. See:

Some resources from Harvard Business School's Baker Library:

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