Business Lawyers in Columbus, Ohio
By Drew Stevens - March 18, 2020 - Startups + VC
At a conceptual level, venture capital is straightforward enough – money is raised, money is invested, and money is paid out to the general partner and limited partners. Digging deeper though, starting and structuring a venture capital fund can be incredibly complex and time consuming. Here, our Columbus venture capital lawyer provides an overview of the key components of a venture capital fund.
1. What type of fund are you starting?
Determining what the overall fund goals and target investments are can be a crucial first step in starting your fund. Key factors to consider include target startup stage, target sector(s), traditional vs evergreen structure, and target geography.
Target startup stage entails deciding if your fund will focus on investing in companies in a particular stage, such as seed, early, or late stage companies. Seed and early stage investments can be on the riskier side but can offer a higher return. Late stage companies have been operating for longer and may offer more stability, but the returns may not be as high as compared to seed and early stage companies.
Further, focusing on early vs late stage companies can determine the number of companies your fund will invest in and the check sizes with those investments. With seed and early stage companies, typically the valuations are lower, and you’ll subsequently be able to write more checks and build a larger portfolio of investments. In contrast, late stage companies may be raising for their Series B or Series C rounds and investing in such companies may require significantly larger check sizes.
Another key consideration is whether to structure the fund as a traditional or evergreen fund. The predominant model is the traditional 10-year fund (also called closed-end funds). Though there are no hard definitions for the 10-year timeline, the 10-year fund roughly spends the first third of the fund’s existence making investments, the middle third managing the investments and making follow-on investments, and last third of the fund cycle harvesting the investments and distributing proceeds to the limited partners and the general partner.
The alternative fund structure is the evergreen fund (also called the open-ended fund). True to the name, the evergreen fund features no hard timeline or termination date. This can offer fund managers more flexibility in having a longer timetable to prospect for and make investments. Evergreen funds can also be very attractive to startups in that the evergreen fund can remove the pressure to grow and sell within the usual five to eight year period with the traditional model.
Final structuring considerations include whether to focus on a particular geographic area and/or specific sectors. A geographic focus can be a particular state (focusing only on companies in Ohio, for example) or a particular region (the Midwest). Sector focuses can be broad (technology or software) or narrow (artificial intelligence or eCommerce).
2. Overall structure of the venture capital fund
A full venture capital fund consists of multiple entities. At a high level, the fund itself is typically a limited partnership formed in Delaware. The members of the limited partnership consist of the general partner and the limited partners.
The general partner manages and runs the limited partner fund. This includes searching for and making investments, raising money from investors, and advising and assisting the fund’s portfolio companies. At times, the general partner may also choose to have a manger handle certain aspects of the fund.
The limited partners invest into and fund the limited partnership. Limited partners typically invest through an LLC or a corporation.
Finally, the limited partnership fund may itself fund subsidiary LLCs. These LLCs may exist to directly invest in the target startup.
Starting a Venture Fund Part II
In Part II of this series, we’ll dive into more detail regarding the mechanics of the general partner and the fund limited partnership.
Columbus, Ohio Venture Capital Law Firm
If you’re considering starting a venture capital fund in Ohio and have questions or concerns with structuring your fund, contact our Columbus venture capital lawyer today.