“The insane levels of complexity in the venture capital legal stack are excluding talent and wealth from entering the asset class,” says Adeo Ressi, CEO of VC Lab and the Founder Institute, who is also the Founding Member of TheFunded. “The documents are unreadable. Unless you are a high-paid lawyer, few understand what they are signing.”
VC Lab has re-written the main agreement used in fund formation, the Limited Partner Agreement (LPA). The new template, called Cornerstone, is a lightweight and easy-to-use template that can get fund managers started negotiating terms with Limited Partners, ahead of engaging high-priced fund formation attorneys. In a matter of minutes, fund managers can customize the Agreement and then immediately start negotiating terms with Limited Partners. Cornerstone is authored to be read and understood by all professionals, not just those with specialized knowledge of the venture capital industry.
An LPA is the operating agreement of venture capital, describing how the fund operates, what the fund invests in and how money is made and shared between the various signatories. The General Parters, who make the investments, sign the LPA with their Limited Partners, the investors in the Fund. This agreement is part of a series of documents and a series of entities needed to form a venture capital fund. To date, fund managers have needed to engage specialized fund formation attorneys to start their firm.
“Fund formation legal is out of control,” says Rich Gora, founder of Gora LLC and one of the authors of Cornerstone. “It is not uncommon to see fund formations cost in excess of $150,000 with big law, and it can cost $10,000 just to review these documents as an investor. The reality is that everyone wants to see this change. It’s no fun for anyone, not the lawyer, not the client nor the investor.”
To provide a sense of just how dense the average LPA language is, below is one paragraph from the 75 page LPA recommended by the International Limited Partner Association (https://go.ilpa.org/WOFLPA), a trade group working to simplify the agreements for limited partners.
Sample LPA Language from the International Limited Partner Association
220.127.116.11 an event of withdrawal (as defined in the Act) with respect to a General Partner, other than an event of withdrawal set forth in Section 17-402(a)(4) or (5) of the Act; provided, that the Fund shall not be dissolved and required to be wound up in connection with any of the events specified in this Section 18.104.22.168 if (i) at the time of the occurrence of such event there is at least one remaining General Partner of the Fund who is hereby authorized to and shall carry on the business of the Fund or (ii) at such time there is no remaining General Partner, if within one hundred and twenty (120) days after such event of withdrawal, the Limited Partners agree in writing or vote to continue the business of the Fund and to appoint, effective as the day of withdrawal, one or more additional General Partners, or (iii) the Fund is continued without dissolution in a manner permitted by the Act or this Agreement;
The effect of this legal complexity is that the venture capital asset class is exclusionary. New managers have to work with these specialized lawyers, and the best ones have massive backlogs and $1,000+ USD hourly rates. New investors, the Limited Partners, have the same problem on the other side of the table.
Cornerstone works to fix this. The whole agreement is 33 pages. All of the economic terms are clearly outlined in the front, versus buried in the document. Complex regulatory and tax language are in an appendix. The document merges a term sheet, a subscription agreement and an LPA into one, eliminating hundreds of pages of legal. The resulting work is much more readable. Below is sample language from Cornerstone.
Sample LPA Language from Cornerstone
2.2. Default. If a Limited Partner fails to make all or any portion of any Capital Contribution or any other amount required to be funded by such Limited Partner, General Partner shall have the right to take any of the following actions in its sole discretion: (a) notify the defaulting Limited Partner and provide for a period for the Limited Partner to cure the default; (b) if the Limited Partner has not made any Capital Contributions, deem the Limited Partner’s Interest in the Fund to be forfeited; or (c) if the Limited Partner has made a Capital Contribution, General Partner may sell the defaulting Limited Partner’s Interest for a purchase price equal to 50% of the lesser of (i) the defaulting Limited Partner’s aggregate Capital Contributions, or (ii) the Fair Value of the defaulting Limited Partner’s Interest at the time of default.
“We spent months taking overly complicated legal language and working to make it readable by business people,” says Hans Kim, another author of Cornerstone. “The team would simplify the language, send it to fund formation attorneys for review, and then simplify the language again. In the end, we have something legally solid and easy to understand.”
VC Lab has released Cornerstone for free. This offering is part of the vision to remove barriers to entry in the high cost and low transparency venture capital world, allowing next generation firms and investors to enter and grow the asset class. Cornerstone is currently localized to work with funds domiciled in Delaware, the most popular to launch funds worldwide. Additional domiciles are coming in the next few months.