Private capital courts mom and pop: Managing the risks of retailization in private capital

The retailization of private capital — the investment by so-called “retail investors” in private capital strategies — is transforming the asset management industry. The primary U.S. vehicles for retail investment in private capital – interval funds, tender offer funds and business development companies (BDCs) – had total assets of over $400m as of year-end 2024, and are expected to more than double by 2029.^[1] Interval funds, tender offer funds, and BDCs each offer periodic investor redemption features, and generally focus on more liquid private capital strategies such as private credit and secondaries, both of which are experiencing strong growth. Retailization is gaining momentum largely because of market forces, with regulators doing their part to facilitate more democratic access to private markets.

Retail capital offers meaningful potential rewards to private capital managers, including increased capital for investment, greater diversification of capital sources and access to potentially permanent or longer-term capital. With those rewards, however, come risks that require careful management. The regulatory regime applicable to retail products differs in important ways from the regime governing institutional private funds. This article discusses the drivers of retailization, the relevant regulatory frameworks for retail private capital vehicles, and the regulatory and litigation risks that private fund managers and sponsors face when entering the retail space — along with practical measures to mitigate those risks.

Economic and other drivers of retailization

The retail investment boom is being driven by a confluence of market conditions, investor demand and regulatory reform. For many private capital managers, the growth in retail investment comes at a welcome time. Fundraising conditions have been sluggish for several years, in part because of sustained demand for capital from capital-intensive investments such as infrastructure (including data centers). In the generally slower exit environment that has persisted recently, institutional investors have delayed reinvestment into new funds until they have received sufficient returns from prior investments. Many private fund managers have added or are considering adding retail products to their fund complexes.

Retail investors are increasingly drawn to private capital because of the potential for higher returns, a desire for portfolio diversification and growing awareness of private capital as an asset class. As fewer companies go public, and companies generally remain private longer before conducting an IPO, private capital is now viewed as an important allocation for certain retail investors. Regulators are also acting to facilitate retailization, including the August 2025 Executive Order to increase access and reduce barriers to alternative assets in 401(k) accounts and reforms in 2025 by the U.S. Securities and Exchange Commission.^[2]

Different investor profiles for retail products

Traditionally, private capital investments in the U.S. were made through private funds exempt from registration under both the Investment Company Act of 1940 (“Investment Company Act”) and the Securities Act of 1933 (“Securities Act”). These private funds typically made illiquid investments, had lifespans of approximately ten years and provided investors with limited liquidity prior to termination. Their investors were generally sophisticated institutions that invested large amounts in multiple private funds.

Those investor characteristics reflected the applicable regulatory regime. To be excluded from the definition of “investment company” under Section 3(c)(7) or 3(c)(1) of the Investment Company Act, private funds could not offer their securities publicly and, in the case of 3(c)(7) funds were limited to investments by qualified purchasers (entities with $25m or more in discretionary investments, or individuals with $5m or more in investments in securities) or, in the case of 3(c)(1) funds, were limited to 100 beneficial owners. To be exempt from Securities Act registration, these funds were limited to accredited investors — certain financial institutions, entities with $5m in assets, or individuals meeting net worth ($1m), annual income ($200,000 individually or $300,000 with a spouse), or financial sophistication thresholds. For registered investment advisers to these private funds to charge a performance fee based on capital gains, investors had to be qualified clients — those with $1.1m in assets under management with the adviser or $2.2m in net worth.

While natural persons also invested in these private funds, they typically met one or more of the eligibility criteria described above, or fell into a narrow category such as individuals managing the fund to demonstrate “skin-in-the-game,” their friends and family or individuals qualifying under the "knowledgeable employee" exception.^[3] Private wealth feeder funds and family offices also have a long history of participating in private capital markets. Thus, natural persons investing in private funds were smaller in number and scope, and private fund managers could limit that investor universe.

In contrast, the retail private capital products available today are being marketed to a broader set of individuals and other retail investors who meet fewer — or none — of these thresholds. Many retail private capital products are offered to investors who are merely accredited investors and, in some cases today and in the foreseeable future, to sub-accredited investors. (Some retail products continue to require higher eligibility thresholds, such as requiring all investors to be qualified clients so the investment adviser may charge a performance fee.) Broadening the investor universe from qualified purchasers or qualified clients to accredited investors — without being limited to 100 beneficial owners — vastly increases the opportunity for retail investment in private capital, and the structure of retail private capital funds enables broader marketing and distribution than is available to private funds.

The economic circumstances and investment objectives of investors in retail private capital products often differ materially from those of investors in private funds. Because many retail products are available to investors meeting lower eligibility thresholds, those investors will typically have less capital to invest, greater liquidity needs and potentially less familiarity with private capital terminology and practices. These characteristics shape how sponsors communicate with investors and how investment advisers manage these vehicles.

The regulatory regime for retail products

Investment Company Act and Securities Act registration

Retail products are typically registered under both the Investment Company Act (or, in the case of BDCs, elect to be regulated under the Investment Company Act) and the Securities Act — in contrast to private funds, which are exempt from registration under both. The Investment Company Act imposes a host of operational and governance requirements on registered investment companies (RICs) and BDCs that do not apply to private funds. Offering registered securities requires detailed disclosure and subjects the retail vehicle and its senior executives to potential liability under Sections 11 and 12 of the Securities Act.

SEC filings

Closed-end RICs must file with the SEC a prospectus and annual and semi-annual reports with full financial statements — including statements of operations, assets and liabilities, cash flows, and changes in net assets, together with notes that include a complete list of investments. BDCs that elect to register under the Securities Exchange Act of 1934 ("Exchange Act") are subject to public reporting obligations, including annual reports on Form 10-K and quarterly reports on Form 10-Q, each of which requires, among other things, a full management's discussion and analysis of financial condition and results of operations, as well as Current Reports on Form 8-K upon the occurrence of designated material events.

Independent board

One significant requirement of the Investment Company Act — and one of the most important distinctions from private funds — is the requirement that RICs and BDCs maintain an independent board.^[4] The Investment Company Act requires board approval, including by independent directors, of investment adviser agreements, codes of ethics, and compliance policies, among other matters. The board also plays an important role in valuation and in administering the redemption process. Where the RIC or BDC has obtained co-investment exemptive relief from the SEC, the board bears important oversight responsibilities for compliance with the terms and conditions of that relief.

Valuation

The Investment Company Act requires that RICs and BDCs value their portfolio securities at market value or, where market value is not determinable, at fair value. Retail private capital funds will typically invest a significant portion of their assets in illiquid or hard-to-value private securities and will need to determine the fair value of those holdings. These valuations are necessary not only for the preparation of financial statements, but because they form the basis for the net asset value (“NAV”) at which the RIC issues and redeems its shares.

Rule 2a-5 under the Investment Company Act establishes the required framework for RICs and BDCs to determine fair value. Rule 2a-5 places ultimate responsibility for fair value determinations with the board, which may designate the investment adviser as its “valuation designee” to make those determinations. Where the investment adviser serves as valuation designee, it must report to the board on valuation matters quarterly and annually with an assessment of the adequacy and effectiveness of its valuation process. Rule 2a-5 also requires that RICs and BDCs establish methodologies for determining fair value, which are subject to periodic testing. Rule 23c-3 under the Investment Company Act requires an interval fund to value its assets at least weekly, and daily for the five business days preceding the repurchase request deadline.

Investor redemptions

Both interval funds and tender offer funds provide investors with periodic opportunities to redeem shares or withdraw investments — more frequently than the opportunities typically afforded by private funds — though the mechanics differ and are governed by distinct rules.

• Interval funds are governed by Rule 23c-3 under the Investment Company Act. They repurchase a percentage of outstanding shares at set intervals, generally quarterly, semi-annually, or annually. Repurchase intervals are a fundamental policy of the fund, must be disclosed in its prospectus, and may not be changed without a shareholder vote, though an interval fund may suspend the periodic repurchase in limited circumstances. By law, the repurchase amount must be between 5% and 25% of outstanding shares; the amount may vary from period to period and is determined by the board at its discretion. Shareholders must receive notice of the repurchase offer between 21 and 42 days before the request deadline. If a repurchase offer is oversubscribed, the board may choose to repurchase up to an additional 2% of outstanding shares or to repurchase shares from all tendering investors on a pro-rate basis. All repurchases must occur at NAV, and the fund must pay investors cash in full within seven business days of the repurchase pricing deadline. Interval funds may not impose a lockup period but may obtain SEC exemptive relief to charge an early redemption fee if a shareholder redeems within two years of acquisition and may charge a fee of up to 2% of the amount redeemed.
• Tender offer fund repurchases are governed by Rule 13e-4 under the Exchange Act. Unlike interval funds, tender offer funds are not legally required to repurchase shares at specified intervals; rather, the board, at its discretion, determines the repurchase timing. There is no regulatory minimum repurchase amount. The tender offer process requires the fund to notify shareholders and file a Form TO with the SEC, which must include required disclosures and attach certain financial statements. As with interval funds, if a tender offer is oversubscribed, the fund may repurchase up to an additional 2% of tendered shares or repurchase a pro rata portion from each tendering shareholder. Rules governing lockup periods, redemption fees, and early repurchase fees are generally the same for tender offer funds and interval funds. Unlike interval funds, a tender offer fund may repurchase shares below NAV, but all repurchases in a given tender offer must be made at the same price. Tender offer funds are required to make "prompt" repayment to redeeming shareholders, though no specific timeframe is prescribed. Some tender offer funds initially provide tendering shareholders with a promissory note and subsequently pay cash — though the SEC staff has at times expressed concerns about the use of promissory notes. Tender offer funds also permit a “hold back” of up to 90 days before paying the full amount to shareholders who tendered all their shares, allowing the fund to audit and confirm share value.

Liquidity of investments

Neither interval funds nor tender offer funds are subject to the Investment Company Act's liquidity risk management rule. Nonetheless, because these funds repurchase shares periodically, they must as a practical matter maintain sufficient cash, liquid holdings and other resources such as available borrowings to meet investor redemptions. Interval funds are required, during the repurchase period, to maintain cash or liquid assets equal to the total amount offered for repurchase; this requirement does not apply to tender offer funds.

Limits on leverage

RICs face significant limitations on their ability to incur obligations that rank senior to their common stock, including debt and preferred stock. Interval and tender offer funds may issue preferred stock only if they maintain an asset coverage ratio of 200% (i.e., $2 of assets for every $1 of preferred stock outstanding) and may incur debt only if they maintain an asset coverage ratio of 300%, both at issuance and on an ongoing basis. BDCs generally may not issue senior securities — whether debt or preferred stock — unless they maintain an asset coverage ratio of 200%, or 150% if approved by shareholders or the board. These leverage restrictions limit advisers’ ability to augment returns through borrowing — a meaningful distinction from private funds, many of which use subscription lines and NAV loans to enhance returns. Closed-end funds often limit their borrowing to bank facilities designed to provide liquidity for managing periodic redemptions and other operational needs.

Affiliated transactions

The Investment Company Act imposes significant limitations on the ability of RICs and BDCs to engage in transactions with affiliates — a key distinction from private funds. These restrictions are designed to protect fund shareholders from conflicts of interest with their investment adviser. Section 17(d) and Rule 17d-1 prohibit registered funds from entering into any “joint enterprise or other joint arrangement” with affiliated persons or with affiliates of such persons. (BDC affiliate transactions are also governed by Section 57 of the Investment Company Act, which is less restrictive in some respects.) Absent SEC exemptive relief for co-investment, closed-end funds may not co-invest in transactions alongside other vehicles managed by the same investment adviser, and other coordinated activities are prohibited unless conducted within the confines of SEC staff no-action guidance or applicable exemptive rules. These restrictions substantially limit RICs’ and BDCs’ ability to participate in private capital transactions where their investment advisers or affiliates also manage private funds.

SEC co-investment exemptive relief

The SEC has for a number of years permitted closed-end registered funds and BDCs to seek exemptive relief to co-invest alongside affiliated vehicles, enabling side-by-side investment in private transactions subject to specified conditions, notwithstanding the restrictions of Section 17(d) and Rule 17d-1. In April 2025, the SEC modified the terms of this relief, affording asset managers of BDCs and tender offer and interval funds greater operational flexibility. For investment advisers seeking to manage both a private fund and an interval fund, tender offer fund, or BDC pursuing similar private capital strategies, obtaining co-investment relief will typically be essential to long-term success.

Co-investment exemptive relief provides a path for registered investment advisers to manage certain retail vehicles and private funds that will regularly invest in the same private transactions. A key requirement of the relief is that when RICs or BDCs co-invest alongside affiliated funds, they generally do so on the same terms — including time of investment, class of securities, price, conversion features and registration rights. Under the SEC's current co-investment framework, the board must approve the RIC's or BDC's participation in a co-investment program and adopt a co-investment policy. The board is not required to approve each individual co-investment transaction but must approve transactions with specified characteristics that the SEC staff views as presenting heightened potential for conflicts of interest.

Multi-class exemptive relief

The Investment Company Act generally limits closed-end funds to issuing a single class of common shares, which can present challenges for RICs investing in private capital that wish to offer different fee arrangements for different types of investors. While all RIC shareholders must pay the same investment advisory fee, an investment adviser may wish to impose other fees – such as shareholder servicing fees, distribution fees, or sales loads – at different levels or for different investor groups. A sponsor may use a master-feeder structure to achieve differentiated fees, but that structure imposes added administrative and regulatory complexity and costs. Tender offer funds, interval funds, and — beginning in 2025 — privately offered BDCs, may obtain SEC exemptive relief to issue multiple share classes, enabling a RIC or BDC to structure fees and sales loads to appeal to various types of investors without the complexity of a master-feeder overlay. Such multi-class orders are subject to specified terms and conditions, including requirements related to share distribution.

Regulatory risks of retail private capital vehicles

As private fund advisers expand into the retail market through interval funds, tender offer funds, or BDCs, they enter a regulatory environment that differs materially from the institutional private fund world. The SEC's examination and enforcement programs treat retail investors as warranting heightened regulatory protection and retail-facing alternative products as higher risk. The SEC staff has identified risks related to retailization — including private fund managers that have recently entered retail markets — as a current examination priority.

The SEC's retail lens

The SEC’s priorities consistently emphasize retail investor protection, particularly in connection with complex or less liquid strategies. As retail access to private market exposure has grown rapidly, examiners now closely scrutinize how advisers market, value, allocate and monitor retail private capital products. When an adviser manages both private funds and retail products, examiners typically review allocation practices, valuation discipline, conflicts of interest, the accuracy of marketing materials, governance processes and differences in fee and expense structures across vehicles.

SEC enforcement actions involving investment advisers to retail clients illustrate the SEC's more protective posture toward retail investors — including for conduct that has not generated enforcement actions when undertaken in the private fund or institutional context. The SEC has been willing to bring cases based entirely on contract language deemed potentially misleading or inconsistent with fiduciary obligations — such as provisions purporting to limit the investment adviser's liability — even where no specific investor harm is alleged. See, e.g., Family Wealth Advisors, IA Rel. No. 6941 (Jan. 20, 2026).

Enforcement actions involving mutual funds pursuing alternative strategies and BDCs further illustrate how familiar private fund risks for investment managers intensify within a retail wrapper.^[5] These actions have alleged deviations from disclosed strategies, misstatements about risk management or worst-case loss scenarios, and inadequate valuation controls.

Private litigation risks of retail private capital vehicles

Expanding into the retail space increases a private fund manager's exposure to investor litigation by introducing a dispersed investor base more inclined to pursue securities claims and by broadening both the frequency and reach of statements that can serve as the basis for liability.

The different investor profiles, disclosure regimes and investing contexts of retail private capital vehicles — as compared with private funds — increase the likelihood of disputes and litigation. The eligibility requirements for private funds typically produce sophisticated, repeat investors with access to the manager and the ability to resolve disagreements through negotiation rather than litigation. Retail private capital vehicles, by contrast, involve standardized disclosures and broad distribution to dispersed investors who often do not have the same interest in preserving access to the manager's future funds and face no practical barrier to bringing suit.

Section 10(b) Disclosure liability

Public disclosures by BDCs and RICs fall squarely within the scope of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which prohibit material misstatements or omissions of fact in connection with the purchase or sale of securities. Whereas institutional limited partners can negotiate side letters providing enhanced information rights, retail investors have no such opportunity. As a result, perceived discrepancies between public representations and fund performance, assets, and liquidity carry heightened legal consequences and are more readily framed as antifraud violations in the retail context.

Liquidity sensitivity as a litigation trigger

Liquidity stress in retail-oriented vehicles can become a litigation trigger, as retail investors are often more dependent on access to invested capital. Recent class action lawsuits by BDC investors alleging materially false or misleading statements concerning valuation and changes to redemption and liquidity terms illustrate how matters such as valuation determinations and portfolio performance commentary – which might be addressed through negotiated governance mechanisms in institutional private funds – can give rise to federal securities fraud litigation in the retail context.

Governance and unequal treatment claims
A fund manager’s entering the retail market can materially affect governance arrangements. In retail-oriented vehicles, differences in fund terms, redemption rights, or information access are more likely to be scrutinized under fiduciary standards and statutory frameworks, increasing the potential for disputes grounded in claims of unequal treatment or governance-related breaches.

Risk mitigation measures for private fund managers entering the retail sector

Retail private capital products are subject to additional regulatory requirements compared with private funds, and their investors have different characteristics and objectives. For asset managers historically focused on private funds that are now entering the retail space, these differences have substantial ramifications for their obligations and risk profiles. The following discussion addresses measures that private fund managers can take to mitigate the regulatory and private litigation risks arising from those differences. Effective risk mitigation begins with selecting the appropriate retail vehicle, investor base, and distribution channels — and extends to reviewing and enhancing compliance programs and adding the personnel and infrastructure necessary to meet new obligations.

Determine the appropriate retail structure

Among the available retail structures — interval funds, tender offer funds, and BDCs — none is inherently “better.” Similarly, no particular investor eligibility threshold — sub-accredited investor, accredited investor, qualified client, or qualified purchaser — is inherently preferable, though the threshold chosen will determine a product’s accessibility. Asset managers considering a retail product launch should assess which structure best fits the contemplated investment strategy, objectives, and investor base. Selecting the vehicle type, investor eligibility, and distribution channels that best align with investment objectives can increase the likelihood of investment success and reduce the risk of future operational or liquidity challenges — and with them, regulatory and litigation exposure.

Investment strategies and objectives

Certain strategies are better suited to particular retail vehicles. For example, a tender offer fund may be the preferred structure for a strategy focused on meaningful “fund of fund” investments in private funds, given its greater flexibility regarding redemption timing and the deadline to distribute cash to redeeming investors. BDCs may be well suited for strategies involving investments in private credit or smaller operating companies but are not viable for strategies that involve investing in private funds.

Investor base and distribution

When determining a retail product's investor base, sponsors should consider several key questions. First, where will demand for the strategy come from? Permitting investments by accredited or sub-accredited investors may be appropriate when the investor base is expected to consist primarily of natural persons, while a higher eligibility standard will be more appropriate where demand is expected to come from institutional investors that do not meet the standards to, or prefer not to, invest in private funds. Second, sponsors must assess whether the Investment Company Act or the Advisers Act imposes limitations on the investor base. For example, if the investment adviser intends to charge a performance fee based on capital gains, investors must meet the qualified client threshold.

Third, because intermediaries selling RIC and BDC shares play a critical role in their successful launch and growth, sponsors must carefully consider available distribution channels, including the roles of affiliated and third-party broker-dealers. Sponsors need to make choices regarding minimum investment sizes, target investors, and whether to implement a multi-class share structure, and also must navigate distributors’ policies regarding the vehicles offered on their platform, customer suitability criteria and minimum investment sizes. Sponsors must weigh the requirements and constraints of available distribution channels and balance investor access against risk management. Due diligence on distributors — conducted before selection and on an ongoing basis — is critical, because a distributor’s deficient sales practices can result in regulatory scrutiny or reputational harm to the sponsor and its fund.

Compliance programs and policies

For investment advisers that manage only private funds, the Advisers Act is the primary regulatory framework. Entering the retail sector requires these investment advisers to enhance their compliance programs to address the more prescriptive Investment Company Act and additional Advisers Act obligations that arise from a retail business line. Consistent with SEC guidance, the investment adviser should comprehensively and proactively identify potential conflicts of interest and other compliance risks that could arise from the new business line, including the conflicts and risks addressed below.

Investment advisory agreements

The Investment Company Act (Section 15 and related rules) imposes substantive and procedural obligations for advisory agreements with RICs and BDCs that are more stringent than the Advisers Act imposes with respect to private funds. Moreover, certain contractual language that is common for private funds may attract SEC scrutiny in the retail context. Asset managers entering the retail sector should confirm that advisory agreements with RICs and BDCs meet the Investment Company Act requirements and do not contain language that could be viewed as misleading when applied in the retail context.

Investment allocation and other conflicts of interest

Where a RIC and a private fund managed by the same investment adviser or an affiliate pursue similar investment strategies, conflicts of interest concerning the allocation of investment opportunities will often arise. For example, where an attractive investment opportunity with limited availability fits the objectives of both the private fund and the RIC, the adviser may have an incentive to allocate that investment to the private fund if the private fund pays a performance fee and the RIC does not, or when the private fund's performance fee is larger. (This will likely arise at times, when a retail vehicle is open to investors that do not meet the qualified client standard and thus cannot charge a performance fee, and because retail vehicles generally pay lower fees than private funds.) Differences in fee crystallization events and hurdle rates for retail and private vehicles may also create incentives to favor certain vehicles. A manager operating both a private fund and a retail fund with similar investment objectives must also consider how co-investment opportunities for private fund limited partners interact with the introduction of the retail vehicle. Beyond investment allocation, managing a retail fund alongside a private fund can present other conflicts, including fee and expense allocation where both funds benefit from the same services but have different expense structures, competing demands on investment personnel, differences in investment holding horizons, and differing redemption obligations and liquidity profiles.

Investment advisers managing multiple private funds should already have policies and procedures addressing investment allocation and related conflicts. However, introducing a retail product can create new conflicts and amplify the significance of existing ones. Asset managers should review — and may need to revise — existing policies and procedures to address the retail product, update disclosures accordingly, and implement or enhance compliance monitoring to confirm that allocation practices and related policies are being applied as described and consistently with fiduciary duties owed to both the private fund and the RIC/BDC.

Co-investment exemptive relief

SEC co-investment exemptive relief imposes conditions relating to board oversight, investment adviser reporting, and investment allocation policies. Advisers and retail private capital funds seeking co-investment relief must develop allocation and reporting frameworks, as well as supporting policies, procedures, and checklists, to facilitate compliance with those conditions. Planning for compliance should begin well in advance of applying for relief. If a RIC or BDC will begin operating before SEC relief is granted, the manager must develop a framework for operating in compliance with Section 17(d), Rule 17d-1, and applicable no-action guidance or exemptive rules.

Valuation policies and disclosures

Investment advisers to private funds will typically have experience determining the fair value of illiquid and hard-to-value assets and managing the associated conflicts and operational processes. However, because retail private capital vehicles are typically continuously offered and provide periodic redemption opportunities, valuation accuracy and timeliness are more critical than in the private fund context, which typically have limited investor redemptions until the end of the fund term.

Meeting the valuation requirements for a retail private capital vehicle will require enhanced policies and procedures, including a documented methodology for determining fair value, enhancing valuation infrastructure and the identification of appropriate third-party valuation providers. Typically, the RIC / BDC board will designate fair value determinations to the investment adviser as permitted by Rule 2a-5, and regardless, investment advisers and boards will need to coordinate their valuation activities. Accordingly, investment advisers preparing to manage retail private capital products should, among other things:

• Confirm valuation policies, procedures and methodologies are tailored to determine fair value for less-liquid assets where market quotations are not readily available.
• Establish and adhere to a protocol for model governance and testing, including documentation of assumptions, overrides, and periodic recalibration.
• Identify mechanisms for independent price verification for thinly traded securities, and for conducting due diligence on third-party valuation providers.

Investment advisers should also review the retail vehicle's disclosures to confirm that they accurately address the valuation process, material valuation risks and assumptions and implications for NAV. These disclosures must be written in plain English, comply with applicable SEC requirements, and align across documents and with actual practices.

Marketing and performance presentation

Marketing and performance presentation is another area where practices permissible for private funds may be prohibited or impractical in the retail context. Registered investment advisers to private funds must comply with Rule 206(4)-1 under the Advisers Act (the “Marketing Rule”). The Marketing Rule is principles-based and permits — subject to certain conditions — the use of hypothetical and extracted performance, which is common for private fund marketing. Regulations for RIC and BDC advertising and performance presentation are generally more restrictive, though the requirements vary depending on the product’s characteristics. In addition, broker-dealers, which play an important role in distributing retail private capital products, are subject to FINRA rules that restrict certain types of advertising, including projections (although FINRA is reassessing these restrictions.) Furthermore, the metrics commonly used to present private fund performance — internal rate of return (IRR) and multiple on invested capital (MOIC) — may be unfamiliar to retail investors. Asset managers entering the retail private capital space must become familiar with the regulatory requirements and prevailing practices for retail marketing and performance presentation and enhance their compliance and investor relations functions accordingly.

Liquidity and cash management

Because retail private capital vehicles must honor periodic redemptions and are subject to leverage limitations, their investment advisers will typically need to enhance treasury and cash management policies and practices. Interval funds must maintain cash or liquid assets equal to the amount offered for repurchase during the repurchase period, and advisers to tender offer funds should take steps to have sufficient resources to meet redemptions during tender offer periods. Managers should identify available liquidity sources for RICs and BDCs, such as permissible bank lines. They should also develop a leverage policy that accounts for the asset coverage requirements discussed above.

Human capital-investment adviser personnel and RIC/BDC directors

Implementing the risk mitigation measures described above will require asset managers entering the retail private capital space to assess their existing compliance, investor relations, and operational capabilities. This will often mean adding personnel, enhancing skills and engaging third-party vendors. Managers should also assess and strengthen their internal litigation infrastructure and resources in anticipation of increased risk of investor litigation.

Sponsors entering the retail private capital space must also devote time and resources to identifying directors, particularly independent directors, and to helping to maintain well-functioning boards of directors that satisfy their responsibilities under the Investment Company Act. Effective boards typically feature directors with a range of skills and experience, including asset management, investment banking, prior board service, knowledge of finance and accounting, and the ability to work effectively together. To identify director candidates, sponsors should draw on professional networks, contacts from trade organizations and service providers, and existing fund directors. Maintaining an effective board requires careful planning and procedures for ongoing board assessments and for succession planning, with the independent directors playing a leading role.

Conclusion

The continued growth of retailization offers substantial potential benefits for private fund sponsors and investment advisers that choose to enter this market. Retail private capital vehicles differ from private funds in their investor profiles, operations and regulatory frameworks. Those distinctions, which contribute to the growth potential of retail private capital, also present new and potentially significant regulatory and litigation risks.

These risks should not discourage sponsors and investment advisers from entering the retail private capital space. Rather, sponsors and investment advisers should acknowledge and address these risks proactively, with the assistance of experienced counsel. This begins by developing a thorough understanding of the Investment Company Act so they can select the vehicle type best suited to their investment strategy and target investors. Sponsors and investment advisers should then proactively assess their current and contemplated activities, enhance their compliance functions and policies, build the necessary infrastructure and add personnel as appropriate. A thoughtful, well-prepared entry into the retail private capital sector is the most effective means of realizing the considerable rewards while managing potential risks.

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