By Dominic Tayco & Alex McCullagh, of Thaddeus Martin Consulting
30 January 2025
1. Introduction
Australia’s Venture Capital Limited Partnership (VCLP) regime has been instrumental in fostering early-stage investment. However, the rapid advancement of blockchain technology and tokenized assets has outpaced the current legislative framework, necessitating modernization to remain competitive.
Currently, VCLPs are confined to traditional equity structures, limiting their ability to invest in security tokens that serve as digital representations of equity. Recognizing that ASIC has classified certain tokenized instruments as equity, it’s imperative to update the VCLP Act to reflect contemporary financial realities.
To ensure the proposed reforms are effective, we evaluate them against three key policy principles:
- Technical Correctness: Aligning the framework with existing legal definitions, financial regulations, and tax structures to ensure seamless integration into the broader financial system.
- Implementability: Designing reforms that are practically achievable, allowing VCLPs to transition smoothly without imposing excessive compliance burdens.
- Organizational Effectiveness: Enhancing capital efficiency, maintaining investor protections, and reducing administrative complexity to strengthen Australia’s venture capital ecosystem.
2. Authors’ Perspectives: Tax, Private Equity, and Debt in Policy Design
Our backgrounds in tax and private equity (Dominic) and structured debt and financial instruments (Alex) provide complementary insights into this issue.
Tax & Private Equity Considerations: VCLPs rely on clear tax structuring and cross-border capital flows. Reforms must maintain tax efficiency while creating practical investment pathways for tokenized equity.
Debt & Structured Finance Insights: Tokenized assets represent a technological evolution of existing instruments. Alex’s experience in debt classification, hybrid instruments, and financial arrangements informs our approach to functional classification and proportional regulation.
- Tax & Private Equity Considerations: VCLPs rely on clear tax structuring and cross-border capital flows. Reforms must maintain tax efficiency while creating practical investment pathways for tokenized equity.
- Debt & Structured Finance Insights: Tokenized assets represent a technological evolution of existing instruments. Alex’s experience in debt classification, hybrid instruments, and financial arrangements informs our approach to functional classification and proportional regulation.
This dual perspective ensures that proposed changes are practical, aligning with the tax and compliance landscape, meeting venture capital investment requirements, and avoiding regulatory challenges.
3. The VCLP’s Outdated Approach to Equity
The Venture Capital Act 2002 (Cth) and the Income Tax Assessment Act 1997 (Cth) restrict VCLPs to investing in traditional shares, excluding tokenized securities even when they function identically to equity.
Historically, policy has evolved alongside financial markets to support innovation. For example:
3.1 Debt & Equity Classification (Division 974, ITAA 1997) – Ensuring Technical Correctness:
- This reform classified financial instruments based on economic function rather than legal form.
- Application to Tokenized Securities: Security tokens should be classified functionally, qualifying as equity if they grant governance, dividend, or residual claim rights, like traditional shares.
3.2 Taxation of Financial Arrangements (TOFA) Regime (Division 230, ITAA 1997) – Enhancing Implementability:
- TOFA introduced mark-to-market taxation for complex financial instruments, aligning tax treatment with economic reality.
- Application to Tokenized Assets: Tokenized venture capital investments should be taxed based on actual market performance, avoiding rigid classifications that don’t reflect financial reality.
4. A Flexible Approach: Lessons from the AFS Licensing Regime
The AFS licensing regime, established under the Financial Services Reform Act 2001 (Cth), transitioned from a rigid rule-based model to a principles-based framework, accommodating market evolution without constant legislative amendments.
Modernizing the VCLP Act using similar flexible principles includes:
- Technology-Neutral Approach: Defining equity by function, regardless of its digital or traditional form.
- Market Integrity & Investor Protection: Ensuring security tokens adhere to the same compliance and governance standards as traditional equity.
- Proportional Regulation: Scaling compliance requirements with risk, avoiding one-size-fits-all restrictions that hinder legitimate investments.
Adopting an AFS-style framework ensures the VCLP regime remains technically sound, practically implementable, and structurally effective, facilitating viable and compliant tokenized venture capital investments.
5. The International Playbook: Singapore’s Approach to Tokenized Venture Capital
Singapore’s Monetary Authority (MAS) has effectively integrated tokenized assets into regulated investment structures:
- Project Guardian: Allows regulated security tokens in venture capital, subject to strict compliance.
- Regulated Secondary Markets: Provides investors with exit options through regulated trading platforms, addressing liquidity challenges in venture capital.
- MAS Standards for Risk Control: Mandates that tokenized assets meet traditional equity governance standards, ensuring market stability and investor protection.
Singapore’s model balances technical correctness, implementability, and organizational effectiveness—offering valuable lessons for Australia.
6. Proposed Legislative Amendments
To align VCLPs with modern investment practices, we propose the following changes:
- New Definition in the ITAA 1997 & VCLP Act (Ensuring Technical Correctness):
Expand the definition of ‘equity interest’ to include digital equity instruments, such as security tokens issued by eligible venture capital entities, provided they confer governance rights, dividend entitlements, or economic interests analogous to traditional shares.
- Amendment to the Venture Capital Act 2002 (Cth) (Ensuring Implementability & Organizational Effectiveness):
- Introduce a VCLP Licensing Framework for Tokenized Investments, modeled on AFS licensing principles, ensuring:
- Only compliant security tokens qualify as VCLP investments.
- Investor protections scale with complexity and risk, ensuring institutional-grade oversight.
- Token issuers undergo due diligence, maintaining compliance with existing venture capital standards.
7. Economic Advancement Through Bipartisan Support
Achieving bipartisan support for these reforms is crucial for Australia’s economic progression. Modernizing the VCLP framework to include tokenized investments can significantly enhance the country’s innovation landscape.
As of the 2019-20 financial year, there were 106 registered Early Stage Venture Capital Limited Partnerships (ESVCLPs) in Australia, investing $353.3 million with $3 billion in committed capital.
The multiplier effect of venture capital investment is well-documented, leading to job creation, technological advancements, and increased global competitiveness.
References
- ASIC’s Information Sheet 225 – Regulation of Crypto-Assets under the Corporations Act
- Provides guidance on how the Corporations Act 2001 (Cth) applies to crypto-assets and tokenized securities.
- Explains when certain tokens qualify as financial products and the corresponding regulatory obligations.
- Source: ASIC
- Rastogi, A., et al. (2023). “Venture Capital Tokenized Investment.” Social Science Research Network (SSRN)
- Examines how tokenization can enhance liquidity and participation in venture capital markets
- Suggests how integrating security tokens can modernize VC structures.
- Source: SSRN
- National Bureau of Economic Research (NBER) – Study on Initial Coin Offerings (ICOs) and Venture Capital
- Analyses the role of ICOs as a financing mechanism for early-stage ventures.
- Compares the effectiveness of ICOs vs. traditional venture capital fundraising.
- Source: NBER
- Financial Services Reform Act 2001 (Cth) – Establishment of the AFS Licensing Regime
- Outlines the transition to a principles-based financial regulatory framework, allowing for innovation without frequent legislative changes.
- Venture Capital Act 2002 (Cth) – Legal Structure of VCLPs in Australia
- Establishes the investment parameters for VCLPs and ESVCLPs, defining eligible investment types and tax benefits.
- Income Tax Assessment Act 1997 (Cth), Division 974 – Debt & Equity Classification Framework
- Provides functional classification of financial instruments, ensuring taxation and legal treatment align with economic substance.
- Monetary Authority of Singapore (MAS) – Project Guardian
- Singapore’s initiative for tokenized securities and blockchain-based financial products within a regulated environment.
- Establishes compliance frameworks for security tokens and venture capital investments.
About Thaddeus Martin Consulting (TMC)
Thaddeus Martin Consulting (TMC) is a prominent advisory firm specialising in legal, compliance, and regulatory strategy for venture capital, private equity, and digital asset markets. With deep expertise in tax structuring, fund governance, risk management, and financial regulation, TMC supports clients in navigating complex investment landscapes while ensuring compliance with evolving legal frameworks.
TMC is committed to innovative, practical, and forward-thinking solutions, bridging the gap between traditional financial structures and emerging investment technologies. Our team of experts provides tailored guidance to venture capital managers, institutional investors, and blockchain enterprises, ensuring that their investment strategies align with both regulatory expectations and market opportunities.
By integrating policy insight, financial expertise, and legal acumen, TMC continues to shape the future of venture capital, tokenized finance, and structured investments in Australia and beyond.
