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Corporate
Organisation of VC Firms in the US
There
are several types of venture capital firms, but
most mainstream firms or wealthy individual investors
invest their capital through funds organized as
limited partnerships in which the venture capital
firm serves as the general partner.
A limited partnership is a partnership that requires
only one partner to assume personal liability
for the business's liabilities (the general partner).
There may be more than one general partner. However,
there may also be other partners (limited partners)
who are passive investors and do not incur personal
liability.
Formation
of a limited partnership requires compliance with
state law; otherwise most states will treat all
partners as general partners for purposes of personal
liability for the business's obligations.
A limited partnership encourages contributions
from investors who might be reluctant to assume
the personal liability associated with a general
partnership. A limited partner is merely an investor;
he or she supplies the capital but is not involved
in the day-to-day management of the business.
In fact, limited partners are prohibited from
becoming actively involved in the on-going management
of the business or they forfeit their limited
liability. The business must have at least one
general partner who is responsible for overseeing
operations and for making daily management decisions.
Sale
of ownership interests in a limited partnership
may be treated as a sale of securities, and state
and federal securities laws must be consulted.
The
most common type of venture capital firm is an
private, independent venture that has no affiliations
with any other financial institution. Venture
capital firms may also be affiliates or subsidiaries
of a commercial bank, investment bank or insurance
company and make investments on behalf of outside
investors or the parent firm's clients. Still
other firms may be subsidiaries of non-financial,
industrial corporations making investments on
behalf of the parent itself. These latter firms
are typically called "direct investors" or "corporate
venture investors."
Other
organizations may include government affiliated
investment programs that help start up companies
either through state, local or federal programs.
One common vehicle is the Small Business Investment
Company or SBIC program administered by the Small
Business Administration, in which a venture capital
firm may augment its own funds with federal funds
and leverage its investment in qualified investee
companies.
While
the predominant form of organization is the limited
partnership, in recent years the tax code has
allowed the formation of either Limited Liability
Partnerships, ("LLPs"), or Limited Liability Companies
("LLCs"), as alternative forms of organization.
However, the limited partnership is still the
predominant organizational form. The advantages
and disadvantages of each has to do with liability,
taxation issues and management responsibility.
The
venture capital firm will organize its partnership
as a pooled fund; that is, a fund made up of the
general partner and the investors or limited partners.
These funds are typically organized as fixed life
partnerships, usually having a life of ten years.
Each fund is capitalized by commitments of capital
from the limited partners. The venture fund will
have from a few to almost 100 limited partners
depending on the target size of the fund. Once
the partnership has reached its target size, the
partnership is closed to further investment from
new investors or even existing investors so the
fund has a fixed capital pool from which to make
its investments.
Making
investments in portfolio companies requires the
venture firm to start "calling" its limited partners'
commitments. The firm will collect or "call" the
needed investment capital from the limited partner
in a series of tranches commonly known as "capital
calls". These capital calls from the limited partners
to the venture fund are sometimes called "takedowns"
or "paid-in capital." Some years ago, the venture
firm would "call" this capital down in three equal
installments over a three year period. More recently,
venture firms have synchronized their funding
cycles and call their capital on an as-needed
basis for investment.
Although
the classical, fixed-term limited partnership
fund has emerged as the dominant form for venture
capital investment, it is illiquid during the
term of the partnership. Difficulties of valuation
have probably been the main reason preventing
the emergence of a secondary market in partnership
shares, although just recently the sheer size
of the venture capital sector, plus perhaps the
woes of the high technology industry, have been
factors tending to encourage the development of
secondary liquidity. Investors locked into partnerships
with many basket-case investments may want to
rescue what little they can from the mess.
Some types of "secondary" partnership have emerged
that specialize in purchasing the portfolios of
investments of existing venture capital firms.
These secondary partnerships, expecting a large
return but taking high risks, invest in what they
consider to be undervalued companies.
As
in the mutual fund sector, the choice of investment
targets is often delegated to specialist advisors
or management agencies.
In some cases, the investor will provide liquidity
to an advisor, or 'gatekeeper', which pools the
assets of its various clients and invest these
proceeds as a limited partner into a venture or
buyout fund currently raising capital. Alternatively,
an investor may invest in a "fund of funds," which
is a partnership organized to invest in other
partnerships, thus providing the limited partner
investor with added diversification and the ability
to invest smaller amounts into a variety of funds.
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