Venture Legal: FAQs and Key Considerations for Fund Managers
Venture legal matters are complex and crucial for fund managers, startup founders, and investors navigating the venture capital and private equity landscape. From fund formation to compliance policies, understanding legal structures and agreements is essential to mitigate risks and ensure smooth operations. This article provides an overview of common legal issues in venture capital, based on expert insights and frequently asked questions.
Frequently Asked Questions (FAQs)
Fund Structure and Management
1. What is the difference between a Venture Capital (VC) firm and a VC fund?
A VC firm is the management entity that oversees one or more VC funds. A VC fund is a specific pool of capital raised from investors (Limited Partners) that the management company deploys into startups.
2. How is a typical VC fund structured?
A standard VC fund structure consists of:
Management Company (ManCo) – Owns the brand, intellectual property, and employs professionals working across all funds.
General Partner (GP) – Manages the fund, receives carried interest, and includes partners involved in specific funds.
Limited Partnership (LP) – The actual fund where Limited Partners invest and where portfolio investments are made.
3. Why separate the Management Company and the General Partner entity?
Separation allows for scalability and flexibility. The Management Company owns the brand and operates across multiple funds, while the General Partner entity manages a specific fund, making it easier to add new funds and partners.
4. What happens if a fund manager passes away or becomes incapacitated?
Most Limited Partner Agreements (LPAs) include provisions for such scenarios. Typically, the fund enters a Limited Operations Mode, restricting activities while the GP and LPs negotiate the next steps.
5. Can a limited partner (LP) also be a venture partner or consultant?
Yes, but doing so may remove their limited liability status, potentially exposing them to fund-related liabilities.
Fund Formation and Compliance
6. Are VC and Private Equity (PE) funds exempt from Beneficial Ownership Information (BOI) reporting?
Yes, if they meet certain criteria and file the necessary exemptions. Generally, management companies, GPs, and pooled investment vehicles are exempt.
7. What are the risks of raising equity money for a Management Company (ManCo)?
Investors in the ManCo receive carried interest in all future funds, which can lead to resentment among General Partners as the firm scales. Additionally, the valuation of the ManCo must be established, affecting share pricing.
8. What is the best domicile for a VC fund catering to US and Southeast Asian investors?
US-domiciled funds (especially in Delaware) are preferred due to favourable regulatory environments. However, tax implications must be considered.
9. Can a fund solicit investments publicly in Australia or North America?
Public solicitation is heavily regulated and requires compliance with specific securities laws. Crowdfunding is typically not an option for venture funds without meeting accredited investor requirements.
10. How do compliance policies affect fund operations?
A robust compliance policy ensures that the fund adheres to financial, tax, and regulatory obligations, reducing risks of conflicts of interest, legal disputes, and penalties.
Investment and Deal Terms
11. How do SAFEs (Simple Agreements for Future Equity) convert?
SAFEs convert into equity when a company raises a priced round. If a group holds a majority of SAFEs, they may negotiate board representation or other investor protections.
12. What are the legal risks of investing in a startup issuing unregistered securities?
Unregistered securities must qualify for SEC exemptions under private offerings. Startups typically ensure compliance through legal counsel.
13. Can a VC fund sign a Venture Partner agreement with a company instead of an individual?
Generally, no. A fund should enter agreements with individuals rather than entities, as fund services are typically personal in nature.
14. How are Limited Partner units redeemed in a VC fund?
LPs do not own shares or units in a traditional sense. Their investments are locked in until liquidity events (e.g., acquisitions, IPOs) generate returns.
15. What happens if a Limited Partner (LP) dies?
The LP’s interest is transferred based on their estate planning. Since these arrangements vary widely, LPAs usually do not specify handling procedures.
Conflicts of Interest and Governance
16. How do emerging fund managers handle conflicts between Fund 1 and Fund 2?
Best practices include:
Clear investment policies to avoid conflicts.
Transparency with LPs about cross-fund investments.
Independent advisory committees for oversight.
17. Can a law firm advising a fund also advise its portfolio companies?
Yes, but conflicts of interest must be carefully evaluated. If the law firm is linked to a GP, they typically assign a different lawyer to advise the portfolio company.
18. How do LPs participate in portfolio companies without conflicts?
LPs may take advisory roles in portfolio companies but should avoid decision-making positions that could create conflicts of interest.
19. Can a GP unilaterally dissolve a fund?
This is rare, but possible. Some LPAs grant GPs this authority in extreme cases (e.g., regulatory investigations). However, LPs can typically vote to enter limited operations mode.
20. How can a contract protect a fund from being taken over by LPs?
Key protections include:
Jurisdictional compliance clauses.
Ethical commitments like the Mensarius Oath.
Fund control mechanisms, such as requiring unanimous consent for key decisions.
Fundraising and Investor Relations
21. When should fund managers verify investor accreditation?
Before discussing fund details, managers should research whether potential LPs meet accredited investor criteria.
22. What happens to origination fees paid by LPs who join after a fund closes?
These fees do not get redistributed to initial LPs. Instead, they typically cover fund setup and operational costs.
23. Can a fund take investments from non-accredited friends and family?
It is strongly discouraged, even if legally permissible. Non-accredited investors often introduce additional compliance and administrative burdens.
24. What are the key considerations when adding a new Managing Partner or Venture Partner?
Equity allocation: Ownership in the ManCo means long-term carried interest in all funds.
Governance impact: Equal ownership can create decision-making deadlocks.
Trust and longevity: New partners should align with the firm’s long-term vision.
25. What is the Parallel Fund structure in the Cornerstone LPA?
Parallel Funds accommodate LPs with specific tax or regulatory needs. They invest alongside the primary fund but operate under different jurisdictions.
Conclusion
Venture legal matters are intricate, requiring careful structuring, compliance, and governance. Whether managing a cap table, navigating fund domiciles, or structuring LP agreements, fund managers must work closely with experienced legal counsel to ensure long-term success.
For deeper insights and expert templates, check resources like VC Lab, Decile Partners, and FINCEN guidelines. If you have specific legal concerns, always consult a qualified venture law attorney.