Why an RIA May Need an Audit for Private and Venture Capital Funds (and What to Consider)

As a registered investment adviser (RIA) managing a private fund, it’s crucial to navigate regulatory requirements effectively, including the question of whether or not you need a financial statement audit. While audits can be a valuable tool for transparency and accountability, they also represent a significant investment of time and resources. Understanding the thresholds that trigger a financial statement audit can help you make informed decisions for your fund and your clients.

Why Should My Private Fund Consider an Audit?

Audits serve several purposes. They can:

1. Enhance Credibility. An audit by a reputable firm can lend credibility to your fund, reassuring investors about the integrity of your financial statements.
2. Fulfill Regulatory Compliance Requirements. Depending on your structure and the assets under management (AUM), regulatory bodies may require audits.
3. Identify Weaknesses. Regular audits can help identify operational weaknesses, helping to ensure better management and risk mitigation.

When Does My Private Fund Need (or Not Need) an Audit?

The need for an audit is primarily determined by the size and nature of the funds you are advising.

1. Private Fund Advisers Exemption
   • To qualify for the private fund adviser exemption, the RIA must have less than $150 million of AUM. There is no limit on the number of private funds under advisement, just the AUM. Once the AUM exceeds $150 million, a financial statement audit is required.
2. Venture Capital Fund Advisers Exemption:
   • To qualify for the venture capital fund adviser exemption, a fund must meet the definition of a venture capital fund. The private fund:
     1. Cannot hold more than 20 percent of its capital commitments in non-qualifying investments (qualifying investments generally consist of equity securities of qualifying portfolio companies) that are directly acquired by the fund.
     2. Cannot borrow or incur leverage, other than limited short-term borrowings.
     3. Cannot offer its investors redemption or other similar liquidity rights, except in extraordinary circumstances.
     4. Must represent itself as pursuing a venture capital strategy to its investors and prospective investors.
     5. Cannot be registered under the Investment Company Act and has not elected to be treated as a business development company.
3. Foreign Private Advisers:
   • To qualify for the foreign private adviser exemption, a fund must meet the following requirements:
     • The adviser has no place of business in the U.S.
     • The fund has fewer than 15 clients in the U.S. or are investors in the U.S. in private funds advised by the adviser.
     • The fund has less than $25 million AUM from U.S. clients and investors.
     • The fund does not hold itself out generally to the public in the U.S. as an investment adviser, nor acts as an investor adviser to a registered investment company or as a business development company.

However, even if you meet one of the above exemptions, there still could be an audit requirement. Often a financial statement audit is required based off fund documents or as a condition of investment, common among institutional investors and high-net-worth individuals seeking additional assurance regarding the fund.

Key Financial Statement Audit Considerations for Private Funds

1. Cost/Benefit Analysis
   Consider the costs associated with hiring an audit firm against the benefits to your fund of enhanced credibility and compliance. This is particularly important for smaller funds that may be more sensitive to costs.
2. Timing of Audits
   If an audit is required, timing becomes critical. Most funds operate on a calendar year basis, so planning your audit to coincide with your fiscal year-end can streamline the process.
3. Choosing an Auditor
   Selecting the right auditor is very important. Look for a firm with experience in your fund type, a good reputation and a solid understanding of the regulatory landscape. A strong partnership with your auditor can help ensure a smooth audit process.
4. Preparing for an Audit
   If you determine an audit is necessary, preparation is key. Maintain organized financial records, ensure compliance with accounting standards and be transparent with your auditor. This not only facilitates a smoother audit process but also fosters a culture of accountability within your organization.

For registered investment advisers in private or venture capital funds, understanding audit requirements is essential for regulatory compliance and building investor trust. By being aware of AUM thresholds, investor demands and regulatory obligations, you can better assess whether an audit is necessary for your fund. Remember, the decision to undergo an audit is not solely about meeting legal requirements; it’s also about enhancing your fund’s integrity and fostering strong relationships with your investors. Taking proactive steps now can help set the stage for long-term success in the competitive investment landscape.

Contact Beth Reho or a member of your service team to discuss this topic further.

Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.