“Business happens over years and years. Value is measured in the total upside of a business relationship, not by how much you squeezed out in any one deal” — Mark Cuban (American billionaire entrepreneur)
In the VC world there are different ways to invest; for example, directly in startups such as an angel, through a traditional VC fund as an LP or in collective funding platforms (crowdfunding) such as Kickstarter. Individual investors disregard the knowledge, network, and heavy lifting required to really build and manage a VC investment portfolio. The traditional way is to invest through a fund manager, who has experience, track record and contacts to ensure their ability to carry out the activities involved in each investment successfully. In this way, LPs are associated with the GPs in search of investments in startups to achieve this objective. This association is established through a “Limited Partnership”.
The Limited Partnership is the association between two or more partners regulated by a legal agreement that establishes the objective of the relationship and determines the operating rules. The fund managers establish a General Partnership where they set the basis to share the profits, administrative responsibilities and debts. In turn, they sign a Limited Liability Partnership with the LPs for the constitution of the fund. The GPs have administrative responsibility for the vehicle and assume fiduciary responsibility while the LP has limited liability.
This Limited Partnership will depend on the structure of the fund, these can be through an independent vehicle that governs all investments in the fund or through the creation of an investment vehicle (side car).
Limited Partnerships must consider 4 main elements for their proper functioning:
- Rules: Defines corporate governance and the decision-making process to protect investors equally. It also delimits the rights and responsibilities of LPs and GPs.
- Risks: It defines the variables to which the committed resources for a previously agreed period are subject. In addition, it determines the risk factors to which the counterparties are subjected, as well as the risk limits that the GP can take when constructing the portfolio.
- Structure: The structure is the legal framework of the vehicle. The structuring will be according to the type and nationality of the investor of the vehicle. The most common geographies are the United States, Luxembourg, Singapore, and the Cayman Islands, among others; these geographies are usually chosen due to the legislative facilities given to establish the Partnership.
- Administration: It is related to the maintenance and payment of vehicle fees, such as trust costs, taxes, audits, etc.
Consider a VC fund in the United States whose investors are CalPERS and CalSTRS. The basic structure of an LP would be to constitute the GP and the LP in Delaware. Both, the fund manager and the LP, are aware of the previous 4 points. LPs are committed to contribute capital for investments and the right to receive returns on investments made by the GP. In addition, the GP will receive a management fee for managing the vehicle and developing the investment activities. The GP can also receive the carry (profit sharing) as long as the investments are successful.
On the other hand, if you are raising a VC fund in Israel, you will constitute a vehicle in Israel for local investors and another vehicle, probably in Europe or the United States, for investors from those geographies.
Sometimes some first-time funds with the desire to gain track record, convince investors and raise capital by establishing independent vehicles for each investment. These vehicles are similar to vehicles established for a full fund, but with concise operating rules and lower administrative expenses. In this way, the LPs will have exposure only to a particular investment at a lower cost.
Other type of VC investors are the Corporate Venture Capital (CVC) funds. These funds are investment vehicles stablished by corporations seeking exposure to innovation and disruptive technologies. Depending on the strategy of the company to which they belong, they will determine whether to establish a similar structure such as an institutional investor or to deploy capital directly through the company’s balance sheet.
Whether you invest capital in VC funds or manage a fund, you should pay special attention to the Limited Partnership Agreement and the terms and conditions stated in the relationship. Do not forget that investing and managing a fund is a long-term game lasting on average up to 10 years, so you better be comfortable playing the game.
Hector Shibata Salazar, adjunct Professor at EGADE Business School and Director of Investments and Portfolio at AC Ventures Fund
Ricardo Latournerie, VC Investor at AC Ventures
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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