Part II: Structural Considerations - Key Factors of Venture Capital Fund Formation
It is essential for managers to understand the structure of their fund, as it will impact tax-related matters, as well as the contents of the internal and offering documents, such as appropriate terms, disclosures, and the specific responsibilities of the manager and the general partner.
Our law firm works with managers as an extension of their management team to develop the structure, terms, and capital raising disclosure documents necessary for the fund formation and launch, setting the foundation to operate and grow the venture capital fund successfully.
Closed-End Fund Structure
Venture Capital Funds are almost always structured as closed-end funds. A closed-end fund is an investment vehicle intended to continue for a fixed period. Venture capital funds commonly have a long-term investment horizon, given that the assets are highly illiquid and difficult to value. A venture capital fund’s term is typically seven to twelve years, with a ten-year term being common.
True investment cycles can last significantly longer, often as long as twenty years. Investors in a closed-end fund are generally not permitted to make redemptions and are limited in making additional capital contributions during the fund's life. Once funded, an investor’s capital will be returned only upon a cash flow event, exit, sale, or refinancing of a fund asset.
Before launching a venture capital fund, managers typically seek to gauge investor interest and obtain non-binding soft commitments from potential investors. A successful launch of an investment fund depends heavily on the manager’s ability to properly garner a critical mass of pre-launch soft commitments, that is, nonbinding expressed interest in the forthcoming fund offering.
After the fund has launched, an extended capital raise period stalls the fund's momentum, makes committed investors uneasy, and can waste valuable allocation time, allowing market forces to shift in ways that undermine the investment strategy. Capital Fund Law Group offers pre-launch services for managers of closed-end funds. Fund managers who take some time to gather soft commitments before the fund’s launch date can effect greater results. However, obtaining soft commitments is fraught with potential liability and should be approached carefully and with appropriate documentation.
Our pre-launch service assists early-stage managers in developing appropriate non-binding documents and reviewing any marketing materials for compliance, allowing managers to gauge investor interest without risking regulatory violations on the state or federal level.
You can learn more about our prelaunch services here.
Common Entity Structure
The typical structure for a domestic venture capital fund, intended solely for US investors, is commonly formed with the following entities:
- A limited partnership (“LP”), generally formed in Delaware, to act as the fund entity, although you can alternatively use a limited liability company (“LLC”).
- An LLC to act as the fund's investment manager, formed in the manager’s primary jurisdiction.
- An LLC to act as the fund's general partner, commonly formed in the manager’s primary jurisdiction.
The diagram below shows a typical structure for a domestic venture capital fund.
The fund, the investment manager, and the general partner act as flow-through vehicles, with the investment manager and general partner formed as LLCs and taxed as partnerships. Most successful venture capital fund managers will develop multiple funds over time. Each successive or concurrent fund formed will have a dedicated general partner. However, each fund will share a single investment manager. From a marketing perspective, this is important, as the investment manager will hold the performance and track record. This entity is the manager’s brand, holding the experience and reputation of the management team.
Offshore Fund Structures
Managers anticipating investments from non-US investors or US-tax-exempt entities may benefit from offshore structures to mitigate the tax burden. The link below offers more information about the most common structures, including master feeder, mini-master, and side-by-side funds.
If you are pursuing venture capital investment management, schedule your complimentary attorney consultation on our Contact Us page, linked here.
Capital Fund Law Group has authored numerous investment fund publications, including instructive eBooks, white papers, blog posts, and sample offering document excerpts with illustrative footnotes. These complimentary downloads are dedicated to helping fund managers understand the legal fundamentals of launching and operating an investment fund.