Part III: Investment Terms - Key Factors of Venture Capital Fund Formation
Investment terms are driven by the fund’s strategy, the market trends within the fund’s sector or target capitalization stage, and the specific needs and objectives of the fund. When properly prepared, the fund’s documents and terms should appropriately protect the manager. A manager’s legal counsel must understand current investment market trends and how those trends impact the fund's strategy.
Venture Capital Terms - Considerations
Capital Fund Law Group’s legal team has extensive experience advising investment funds on all aspects of their business, from capital raising and fund formation to implementing their business models. Representing a broad range of asset managers lets us keep abreast of emerging industry trends. We understand that no two funds or investment advisors are identical; each client has unique objectives and circumstances.
During the formation process, fund managers designate which of the fund's expenses will be borne by the manager and which will be borne by the fund. Typically, the fund bears expenses directly related to forming and operating the fund, including formation costs, accounting, legal services, regulatory brokerage costs, clearing costs, administrative filings, etc.
Investment Manager Compensation
A venture capital fund manager’s compensation includes a management fee (typically 1%-2% of committed capital) and a performance compensation (generally approximately 20% of the fund’s net capital appreciation). There are several fees that fund managers can charge, depending on the fund’s negotiating position with investors. We recommend that the shorter the manager's track record, the more streamlined the fee structure should be.
When private equity fund investors subscribe to an investment in the fund, they usually do so by entering into an agreement to invest a certain sum, known as a capital commitment. When the manager is ready to receive a specific percentage of the investor’s capital commitment, the manager makes a capital call. Once the manager initiates a capital call, the investor has a fixed period to contribute the committed capital (typically ten days), and in doing so, investors will satisfy this obligation. Once contributed, an investor’s capital will be returned only upon a capital event, such as a sale or refinancing of all or a portion of the fund’s assets, recognizing income, or other events resulting in positive cash flow from operations, based on the fund’s distribution waterfall.
Unlike private equity funds, where a preferred return is typically anticipated, venture capital funds rarely include a preferred return. The long hold times typical of venture capital funds mean that general partners must delay their returns for many years. Adding a preferred return would extend that even further.
Most offering documents allow the manager to negotiate special terms with a select investor, referred to as side letters. Often the special arrangement involves better economic terms, such as reduced management fees. Side letters do not apply to other investors in the fund, and Managers must not allow side letters to prejudice other investors. For example, avoid side letters that provide additional information rights or preferential allocation.
When forming a venture capital fund, managers should consider many factors that account for the various needs of the investors and investment manager and satisfy all applicable regulations.
Managers should expect their legal counsel to bring fund formation expertise, advise on legal abilities and restrictions when raising capital, and remain available as legal counsel following the formation and launch.
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.
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.