Categories
Accelerator Alumni Insights

Launching a Venture Firm with VC Lab, by Adil Jafry

About the Author

This article was written by Adil Jafry, who is participating in the 4th cohort of VC Lab. Adil is an experienced entrepreneur, who is passionate about space exploration, and he has further expertise in energy, investment banking and general management. Notably, after interning at NASA, he co-founded Chandah Space Technologies.

VC Lab allowed me to pull together all the necessary documents, resources, and systems required to start my venture firm

In Spring 2021, I found myself in the process of exploring the next leg of my professional career.

A couple of friends recommended I consider the VC Lab program, a highly engaging and rigorous hands-on program for aspiring venture capitalists headed by Adeo Ressi and Mike Suprovici, both experienced entrepreneurs and venture capitalists.

The last ten weeks have enabled me to develop a strong, focused fund thesis

So far it has been a commitment of +50 hours each week. The primary focus of the effort has been to get the presentation and the model right so that I can clearly articulate my unique approach and portfolio construction design to potential investors and the companies in which we plan to invest.

I plan to focus on investing in early stage companies in the cleantech and sustainability sectors in the US, and my mission is to support visionary entrepreneurs looking to transform how we harness and use energy in all walks of life.

Distilling an investment thesis and the sub-sectors within sustainability has been the central task

Combining that with a geographical focus and the value-add that my team brings (by investing in the portfolio companies and providing them support) has created a strong foundation for estimating a fund’s returns over its life — across various investment scenarios and fund outcomes.

Building an analytical framework that is specific to our thesis has been an important exercise, since venture investing follows a power curve law, where 1 or 2 investments within a successful firm’s portfolio generally return the entire fund and the requisite upside, while the rest of the companies in the portfolio barely break even.

This analytical framework serves as a guidepost for iterative future reflection, as each investment gains momentum to begin its journey towards growth and value accretion— or vanishes, as entrepreneurs pivot to spend their energies on other ideas.

It has been quite an eye-opening and an exciting experience for me

Also inextricably tied to this process has been the ever present guidance from VC Lab. Through weekly AMA (“Ask Me Anything”) sessions, I have learned about the optimal number of capital calls a fund should consider making, the fund’s expected life (and potential future extensions), the optimal investment period, the merits of making follow-on investments, and the intricacies of recycling management fees.

One topic that has universally been of concern to the international members of my cohort is the fund domicile and formation process — which varies by the country in which the fund is operating. Thankfully, I am domiciled in the US — where the regulatory framework is mature and well understood by the investor community.

While most of the members of my cohort are first-time fund managers, there are more than a handful who are already successfully managing VC funds and have joined the program to simply learn the “VC Lab way” of building and managing their future funds.

The weekly VC Lab webinars and AMAs have provided important cues on team development, deal warehousing, and trends in valuation and deal structuring

I am also planning to leverage VC Lab’s new “Fund In A Box” (FAB) offering, which can serve as a scalable mid- and back-office platform for my fund, supporting future capital calls and closings. FAB will also integrate with my LP and portfolio management systems.

With eight weeks left until my firm’s formal launch, I am now in the process of rounding out a strong team of qualified venture partners and advisors who share my passion for supporting visionary companies bringing transformative products and services to life that will help drive a sustainable future for our planet.

The free 16 week VC Lab program provides guidance, structure and a network to complete a fund closing in 6 months or less. Since mid 2020, VC Lab has helped launch 75 venture capital funds around the world.

Disclaimer: This post is not directed to any investors or potential investors, and does not constitute an offer to sell or a solicitation of an offer to buy any securities.

Read more from Adil Jafry on his Medium

Categories
Cornerstone LPA Insights

Cornerstone is Step 1 of Fixing the VC Legal Stack

The time has come for change in venture capital

Adeo Ressi

“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 83 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

18.2.1.1 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 18.2.1.1 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.

You can download Cornerstone here, and read about how to customize Cornerstone here.

Questions?

Categories
Cornerstone LPA Insights Resources

How to Use Cornerstone to Form a Fund

Cornerstone by VC Lab is a lightweight and easy-to-use Limited Partnership Agreement (LPA) designed to simplify investing in the venture capital asset class by reducing the use of high-priced fund formation attorneys. Venture capitalists starting a new fund can customize and negotiate investment terms without engaging a law firm. 

The Cornerstone Agreement is short, easy to read and easy to customize. The economic terms of the fund are clearly laid out in the beginning of the Cornerstone Agreement, and General Partners can customize certain terms to fit their fund’s needs. On a high level the process is as follows:

  1. A General Partner takes the Cornerstone Agreement and customizes plug variables in the Key Economic Terms for a new fund offering.
  2. The General Partner shares the customized Cornerstone Agreement with potential Limited Partners for feedback on the terms.
  3. Once the terms are agreed, the General Partner engages with a law firm to form the fund entities using the pre negotiated Cornerstone Agreement.

In this article, we are going to explain the process to customize the Key Economic Terms for the needs of a specific fund. There are 24 terms to customize in the Cornerstone, listed alphabetically. For the purpose of explaining the terms, they are re-grouped by purpose.

Each key term is bolded and in parenthesis and is followed by the term’s definition. If there are options for the term, General Partners can choose from the bracketed pre-filled options. The commonly used options are underlined to help see what most next generation General Partners choose.

To prepare the Cornerstone Agreement, simply choose the item in brackets or fill in blank spaces, and remove any other unused options. Then, save the agreement, preferably as a PDF, and you are ready to share with potential investors. Let’s look at the specific terms.

The Team Terms

The Cornerstone provides an easy access way for General Partners to define the various roles within a venture fund. 

First and foremost, there are the Key Individuals who are primarily responsible for running the fund and should devote most of their time to the affairs of the fund . Next are the Advisory Committee members, which often include Limited Partners, who adjudicate conflicts of interest or making investments outside of the fund thesis. Lastly, there is the Partnership Representative, who is the main contact person for US tax purposes.

The Key Individuals and the Partnership Representative are specified by the General Partner before sending out the Cornerstone to Limited Partners. It is recommended that the Advisory Committee members are elected once you are close to closing and have a sense of any Limited Partners that you want on the Committee. Being on the Committee can be offered as a perk to potential investors.

Key Individuals” means the following individuals identified as signatories of General Partner:
[First_Name Last_Name]
[First_Name Last_Name]

Advisory Committee”initially means the individuals listed below. If no individuals are listed, then an Advisory Committee may be formed at the discretion of General Partner. 
[First_Name Last_Name, Phone Number, Email, Address]
[First_Name Last_Name, Phone Number, Email, Address]
[First_Name Last_Name, Phone Number, Email, Address]

Partnership Representative” initially means:
[First_Name Last_Name].

The Strategy Terms

The Cornerstone Agreement encourages General Partners to have a defined focus and strategy for their fund. The General Partner can input the Sector, Stage and Territory for the fund thesis, which gives Limited Partners comfort that the fund will focus resources on mutually agreed areas.

Like most LPAs, the Cornerstone Agreement also defines a series of Prohibited Sectors that the fund will not invest in, and there is a common list of sectors that you can choose from. As an example, Limited Partners often do not want venture capital firms to invest in real estate, gambling, or alcohol. It is recommended to choose as many of these as possible given your industry and expected investments, and it is possible that some Limited Partners may ask for more.

Sector” means the following Sector or Sectors in which the Fund expects to invest: 
[___________]

Stage” means the anticipated stage of Portfolio Investments: 
[Accelerator] [Angel] [Pre-seed] [Series Seed] [Series A]

Territory” means:
[Worldwide] [United States]

Prohibited Sectors” means securities traded publicly on a securities exchange and the following sectors or industries:
[Alcohol] [Gambling] [Weapons] [Real Estate] [Cryptocurrency] [Blockchain] [Controlled Substances banned under U.S. Federal Law] [________]

The Timing Terms

The Cornerstone Agreement includes a number of timing related terms, and many of these are important. The most important is the Fund Duration, which is the amount of time that the fund has to make primary investments, make follow-on investments and secure exits. Most Limited Partners expect the Fund Duration to be set at 10 years, and there is normally a Fund Duration Extension of 2 one year periods, since exits are taking longer and longer to occur. For early stage funds, rather than extending the Fund Duration, it is more common to have a Fund Duration Extension for three or four years, as the extension years do not have fees.

Some other important timing settings are the Investment Period, which is the amount of time that a fund has to make primary investments, and the Fundraising Period, which is the amount of time after the first close that the General Partner has to complete fundraising for the fund. The standard Investment Period is 4 years, and a recommended Fundraising Period is 18 months. The shorter the Investment Period, the shorter the Fundraising Period should be, logically.

The last two timing terms are the Fiscal Year, which most funds set as the calendar year to align with tax filings, and the Capital Call Notice Period, which is the amount of time Limited partners have to wire funds. For new managers that do not know their Limited Partners well, it may make sense to set the Capital Call Notice Period to either 15 or 30 days.

Fund Duration” means the following anniversary from the Initial Closing Date:
[10th year] [12th year] [8th year]

Fund Duration Extension” means:
[2 one-year periods] [1 year] [0 years (no extension)]

Investment Period” means the period from the Initial Closing Date up through the date that is the following number of years after the Initial Closing Date, during which the Fund can make its initial Portfolio Investments:
[4] [3] [5]

Fundraising Period” means the period commencing the Initial Closing Date and ending on the date that is the following number of months from such date:
[18 months] [12 months] [9 months]

Post-Investment Period” means the period after the last day of the Investment Period.

Fiscal Year” means, unless otherwise required under the Code, each year ending on the date below. In the case of the first and last Fiscal Years of the Fund, Fiscal Year shall mean the fraction thereof commencing on the Initial Closing Date or ending on the date on which the winding-up of the Fund is completed, in each case unless otherwise determined by General Partner and permitted under the Code.
[December 31] [September 30] [June 30]

Capital Call Notice Period” means the following number of days after a Capital Call Notice allowed for a Limited Partner to deliver cash to the Fund in the amount requested:
[10 days] [15 days] [30 days]

The Economic Terms

The economic terms in the Cornerstone Agreement are the backbone of the agreement, and all of these are important. The Carried Interest Percentage sets the carry for the fund, and, with most new managers, this will be 20% for the classic “2 and 20” model.

The Management Fee is split in the Cornerstone between an Investment Period Management Fee and a Post-Investment Period Management Fee. If you wanted a straight 2% for the ten years of the Fund Duration, then you could set both periods to 2%

However, most funds require more effort during the Investment Period, so the Management Fee might be higher, such as 3.5%. With a 3.5% management fee for 4 years of the Investment Period, then a 1% management fee for the remaining 6 years of the fund, the average management fee is 2%.

The next term is the GP Commitment Percentage, which is the amount of money that the GP agrees to invest in the fund. Most Limited Partners in funds over $5 MM will ask for this to be set at 1%, but this is negotiable. The GP capital contribution to cover the GP Commitment Percentage is paid at the same ratio and same time as capital calls are made, so this is a smaller commitment than it may seem.

The Maximum Portfolio Investment Percentage defines how much of the fund can be invested in any one single portfolio company as a percentage of the fund. This is an important economic term for fund strategy, as it affects the number of portfolio companies that a fund can invest in. Most funds set this at 10%, which means that they will have at least 10 portfolio companies, since no one company can get more than 10% of the fund. For smaller funds that have a more focused investment strategy, this amount may be higher, such as 25%.

The Organizational Expenses Cap refers to a spending limit on the various setup expenses for a fund. Normally, the fund pays for the expenses to get established separate from the management fees, and Limited Partners want these expenses to be capped. Any overages are normally paid for from the management fees. The Organizational Expenses include legal, registration and other filing fees, which tend to scale with the size of the fund. A typical amount for a smaller fund is $50,000.

The Recycled Amount refers to the amount of money as a percentage of the total fund size that a fund can claim back from distributions to invest in additional deals. Recycling is a good way to reduce the effect of management fees and increase portfolio diversity, but it can also be complicated to manage from a fund administration standpoint. As a result, most new managers avoid recycling and set this to 0%.

The last economic term, Successor Fund Threshold, is important because it defines how much of the first fund must be invested before the General Partner is permitted to raise an additional fund. The lower the threshold, such as 50%, the faster the General Partner can start building the firm value. Most Limited Partners want 70%, and most new managers will want 50%

Carried Interest Percentage” means, for purposes of calculating the Carried Interest of General Partner, the following percentage:
[20%] [25%] [15%] [10%] [__%]

Investment Period Management Fee” means the annual management fee during the Investment Period determined by multiplying the following percentage by the aggregate amount of Capital Commitments of all Limited Partners:
[3.5%] [2.0%] [3.0%]

Post-Investment Period Management Fee” means the annual management fee during the Post-Investment Period determined by multiplying the following percentage by the aggregate amount of Capital Commitments of all Limited Partners:
[1.0%] [2.0%] [1.5%]

GP Commitment Percentage” means, for the purpose of calculating General Partner’s commitment to contribute to the Fund, the following percentage:
[1.0%] [0.0%] [0.5%] [__%]

Maximum Portfolio Investment Percentage” means the following maximum percentage of the aggregate Capital Commitments made by all Partners to the Fund that may be invested in any single Portfolio Company:
[10%] [5%] [25%]

Organizational Expenses Cap” means the following cap on fees, costs and expenses, including that of counsel to General Partner, incurred in connection with the organization of the Fund and the offering of Partnership Interests:
[$50,000] [$100,000] [$75,000]

Recycled Amount” means, for the purpose of allowing the Fund to make additional  investments from distributions provided to the Limited Partners, the product equal to such Limited Partner’s Capital Commitment times the following percentage:
[0%] [10%] [20%]

Successor Fund Threshold” means when the following percentage of Total Capital Commitments has been invested into or committed for Portfolio Investments  and Fund Expenses: 
[50%] [70%] [0%]

The Reporting Terms

The Cornerstone Agreement has a key reporting term, Financial Statements, that defines how the General Partner prepares the fund’s financial statements. Most new managers and small funds will choose “Certified by General Partner,” since Reviewed or Audited financial statements can cost in excess of $10,000 per year to complete, and require extensive time and effort to accomplish.

Financial Statements” means the following type of balance sheet, income statement and cash flow statement for the Fund:
[Certified by General Partner] 
[Reviewed by a Certified Public Accountant] 
[Audited by a Certified Public Accountant]

The Control Terms

The Cornerstone Agreement control terms focus on defining what percentage of Limited Partners by ownership can take action within the fund, which is the Majority in Interest of the Limited Partner. The two primary actions are choosing an Advisory Committee member and entering Limited Operations Mode, where fund operations are put on hold. This is commonly set at a supermajority, 66 ⅔%. A lower percentage favors control by the Limited Partners, and a higher percentage favors the General Partner.

Majority in Interest of the Limited Partners” means Limited Partners holding more than the following aggregate Commitment Percentages held by all Limited Partners:
[66 2/3%] [75%] [50%]

The Final Agreement

Once a General Partner sets all of the terms in the Key Terms section of the Cornerstone Agreement, the document will look like the example below. It is recommended that you create a PDF of the Cornerstone Agreement, and email it to potential investors for feedback.

Categories
Accelerator Alumni Insights

XY Ventures: Interview with Simon Olson

Watch the interview with Simon Olson, alumni of VC Lab and the founder & managing partner of XY Ventures, a seed-stage fund that bridges the Nordics and Silicon Valley startup ecosystems. 

On Simon.

I have an entrepreneurial background.

At MIT, as part of an accelerator program, we raised some venture capital and worked on our startup Y-Box. After that experience, I ended up working with a big IT company in the Nordics called TietoEVRY. Heading up the ‘Innovation Studio’ and later on the ‘Ideation and AI’ program I was looking for “the next big thing“. From there, through my network and accelerators, I took on a lot of pro bono work in the Nordics and in the States. That eventually led me to the opportunity to join VC Lab, after I was invited to apply.

On XY Ventures.

We build a connection between the Bay Area and the Nordic region, enabling strategic bilateral relations between two of the most unicorn dense ecosystems in the world.

XY Ventures is a seed stage venture capital firm. Typically we work with accelerators in the Bay Area, where either myself or one of my partners have a relationship in mentoring startups that have a connection to the Nordics. This way we can work with founders very early on. It matches well with our investment thesis, which is to focus on digital disruptors.

On Founders.

The biggest thing for us is grit.

We look for people who give themselves no other alternative other than to succeed. For example, in the Nordics founders typically work on their startup as a side job until receiving venture capital. We prefer to work with founders who have already made the jump to running their startups full time. We don’t tend to invest pre-product startups.

On Innovation.

AI backed, manufacturing automation and fintech fraud detection

With my experience and interest in DeepTech, one application of AI that interest me is automation within manufacturing, which is an area where I have some experience. Another exciting use case of AI is fraud detection within financial services / FinTech, which has been a key area where a lot of the innovation has come from the Nordic region.

On Sweden.

There are a lot more people who want to become entrepreneurs compared to 10 years ago.

The ecosystem in Sweden is really exciting. Traditionally the community has been really tight-knit and a lot of the entrepreneurs know the VCs and vice-versa. We are now seeing a new wave of impact focused entrepreneurs coming into the scene and I think that is really exciting.

On the flip side, the VC scene is also very interesting in Stockholm. A lot of the VCs here come from a private equity background as opposed to ex-entrepreneurs. You can see it in the Series A venture rounds here where most are backed by P.E. firms / individuals within VC funds with that background. Notably, there aren’t that many seed funds in the region. At the same time we have a lot of accelerator programmes focusing on the ‘ideation’ phase. So it makes it really interesting to be a VC between this gap unfolding int the market.

On Being a New Manager.

The hardest thing hands down has been fundraising.

A lot of the LPs in this region expect emerging fund managers to have a private equity background and experience in the financing side rather than the company building aspect. It has been an uphill battle to explain to some LPs how that aspect works and that we aren’t just buying lottery tickets.

Secondly, building a team that is passionate and believes in the mission can be challenging , especially when you are a new fund manager and are relatively less known. Right now we have 8 people in our team. It takes time to build relationships and trust as a new manager.

On the Plan.

We’re aligning ourselves for the final close.

Since graduating, we’ve built a team which includes some senior members with private equity backgrounds. We have one more person to on board before the final closing.

I’m still on the lookout for more people who believe in our thesis of bridging Silicon Valley and the Nordics. We’re keeping our heads down until our final close at which time we will start thinking about our second fund and build up the network to close for that fund.

I wouldn’t say that this was even in my dreams about a year ago. It has been a roller-coaster of a ride in a good sense. We are thrilled to be working with VC Lab in our journey.

Categories
Cornerstone LPA Insights Legal Templates

Cornerstone Limited Partner Agreement

Cornerstone is a lightweight and easy-to-use Limited Partnership Agreement for next-generation venture capital funds. It was released by VC Lab in October of 2021. Cornerstone is designed to reduce mundane and expensive fund formation activities, removing barriers of entry for new managers and new limited partners to enter and grow the venture capital asset class.

A Limited Partnership Agreement (LPA) is the document that forms and governs a venture capital fund. It specifies the rules between the general partners, who make portfolio investments, and their investors, the limited partners. It serves as the operating manual for the venture business.

Traditionally, the LPA is accompanied by a Term Sheet and a Subscription Agreement, and this set of documents normally runs over a couple hundred pages in length. Cornerstone unifies a Term Sheet, a Limited Partnership Agreement and a Subscription Agreement into one document, and Cornerstone is just 36 pages long.

Cornerstone is currently localized for fund formations in Delaware, United States. In surveying 73 next generation venture capital firms from around the world, 52% have chosen Delaware for their domicile. Additional localizations for Cornerstone are being planned for other popular fund formation domiciles. You can learn more about fund domiciles in this Venture Capital Domicile Report

How to Use Cornerstone

A sample Key Economic Term from the Cornerstone template agreement
with plug values for the general partner to customize.

Cornerstone is designed for a General Partner and Limited Partner to start discussing terms for a new venture capital fund without needing an expensive fund formation lawyer on either side. Here are the three steps to use Cornerstone:

  1. A General Partner takes the Cornerstone template agreement and customizes plug variables in the Key Economic Terms for a new fund offering.
  2. The General Partner shares the customized Cornerstone with engaged limited partners for feedback on the terms.
  3. Once the terms are agreed, the general partner engages with a law firm to form the fund entities using pre negotiated agreement.

The simplified process eliminates billable hours with fund formation attorneys, who often charge an hourly rate in excess of $1,000 USD. VC Lab is making Cornerstone available for free.

Four venture capital firms have used Cornerstone and this three step process to close on capital, and more have started subsequently. More fund are in process to use Cornerstone now, and a few of their experiences are quoted below:

I decided to create my fund in Delaware as a general partner in Latin America, and we selected Cornerstone for our LPA. My investors loved it because it is easy to understand, despite being from outside of the United States, and, for many of them, it was their first investment as an LP. It helped with my closing.

David Alvo Verdugo, Impacta VC

I’ve been in fund management for more than a decade before launching my own Fund. Compared to the massive and complex LPAs I have seen in the past, the Cornerstone LPA is dead simple to use.  This will enable more high net worth individuals to understand and enter VC as LPs.

Kevin Brockland, Indelible Ventures

I was able to edit Cornerstone and send it to my Limited Partners without the help of attorneys. The negotiation was very efficient, and I was able to manage the process in the way that I wanted to.

Bade Aluko, White Hibiscus Capital

If you have suggestions, questions or comments, please add them under “Leave a Reply” below. Cornerstone will be updated with new versions semi-annually, and you can download the most up-to-date agreement here.

Legal Innovations of Cornerstone

Cornerstone was written by lawyers for business people, whereas most Limited Partnership Agreements are written by lawyers for lawyers. A number of legal innovations are introduced with the agreement, including:

  • Cornerstone consolidates all of the key economic terms into the front of the agreement, saving readers the ability to scan through dozens of pages to find critical information.
  • Cornerstone moves complex tax and regulatory language to the back of the agreement, allowing the document to read more clearly and be localized more easily. 
  • Cornerstone simplifies the operational components of the fund to 13 pages by eliminating definitions of numerous eventualities, leaving multiple decisions at the description of general partners and limited partners.
  • Cornerstone introduces concepts of fairness and ethics, adding an optional affirmation for all signatories to pledge support for the Mensarius Oath.
  • Cornerstone removes references to specific laws that already govern the agreement and reduces cross referencing, allowing the agreement to be read without needing to refer to other documents.

Special Thanks

VC Lab would like to thank everyone for their contributions to this groundbreaking legal agreement. Cornerstone was drafted over five months by VC Lab in conjunction with Rich Gora and Hans Kim. A number of U.S. and global law firms have reviewed and provided feedback on the drafting. Dozens of limited partners and general partners have also contributed feedback and ideas.

Questions?

Categories
Insights Resources The Domicile Report

Venture Capital Domicile Report by VC Lab

The following information is provided for illustrative purposes only and is based on publicly available information as of September 2021. The complexity and evolving nature of securities regulations and global tax law may change the analysis below. There may be other factors to consider when choosing where to domicile your fund, so you should consult legal counsel or a tax advisor when determining where and how to structure your fund. 

Overview

Launching a venture capital fund can be challenging due to the complexity of the factors to consider, which often creates a high barrier to entry for emerging fund managers. In particular, fund structuring and determining where to domicile the fund can be confusing, costly, and time consuming due to the lack of forthcoming information available. This report aims to provide some guidance regarding potential fund domiciles for venture capital funds. The jurisdictions included here are not exhaustive, however they include commonly used and established fund domiciles. 

Below are the factors that are frequently considered when determining where to domicile a fund:

  • Tax Optimization
    • Where are your investors located?
    • Where do you intend to invest?
  • Cost
    • What are the set up and formation costs?
    • What are the annual maintenance costs?
  • Timing
    • How long does it take for formation?
    • How long does setting up bank accounts and other fund support activities take?
  • Fund Marketing Regulations
    • Do you need registration or licenses to market the fund and how long to these take to get?
    • What are the requirements about who you can market to and how many investors can you have in a fund?
Popular Domiciles by Region
North America

Popular > Delaware, Caymans

Canada > Canada

USA > Delaware

Mexico > USA, Canada, Caymans, Mexico

Central & South America

Popular > USA, Canada, Caymans

Brazil > Brazil

Australia & New Zealand

Popular > Local

Europe

Popular > Local, Luxembourg, Netherlands

UK > UK

Middle East

Popular > Local

Africa

Popular > Mauritius, Delaware

Asia

Popular > Singapore, Caymans

Hong Kong > Caymans

Singapore > Singapore

73 Next Gen Venture Capital Firms launched with VC Lab

A first time fund manager will likely have limited resources (both time and money) to devote to determining where to domicile their fund. While fund formation costs can be paid from fund expenses, engaging legal counsel or a tax advisor can be costly and so most fund managers have some sensitivity when it comes to the cost of seeking fund structuring advice. In addition, the time to form a fund differs across jurisdictions as some jurisdictions have more onerous filing requirements. There are some service providers that can handle fund formation on behalf of a fund manager, however these services often come at a hefty price.

Broadly, fund managers should consider the regulatory regimes that apply to the fund because this will inform how a fund manager can engage potential investors and approach fundraising activities. Fund managers should also be aware of compliance requirements related to securities laws and any ongoing compliance requirements for the fund or its affiliates. Some jurisdictions also have physical presence requirements that fund managers should be aware of before proceeding with forming their fund. 

Perhaps the most important factor to consider is tax treatment. Fund managers should be optimizing for tax efficiency for the fund and its investors. This can be a sticking point for potential investors, so fund managers should consider where the fund’s potential investors are located, where the fund will be investing, and whether there are any applicable tax treaties that make a certain jurisdiction an attractive option for the fund’s investors.

It is important to note as well that fund managers may structure their fund entirely in one jurisdiction or they may take a “hybrid approach” in which the fund entity, the general partner entity, and the management company are formed in different jurisdictions. Taking a hybrid approach may be more tax efficient for the fund manager.   

There are some valuable resources online that can be helpful, particularly free templates or guides published by law firms or the official venture capital association of a jurisdiction. For example, the National Venture Capital Association in the US publishes helpful guidance and template documents on their website. The breakdowns linked to below include links to the relevant venture capital associations, if any. 

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Fund Domicile – Delaware, United States

Delaware Summary

Fund Structure Limited Partnership or Limited Liability Company
Costs$200 to form a limited partnership plus an additional $50 for a certified copy of the formation certificate
$90 to form a limited liability company plus an additional $50 for a certified copy of the formation certificate
$300 annual LLC/Partnership Tax 
Ongoing securities filings are also relatively cheap 
Formation can become costly depending on the law firm or tax advisor engaged
TimingEntity formation can be done quickly and can be expedited on a same day turn-around for an additional fee
Fund Marketing Investment Advisers Act of 1940
Securities Act of 1933
Typically no general solicitation and all investors must be US Accredited Investors
If you do engage in general solicitation, a third party must verify all investors’ Accredited Investor status (additional cost and risk to the fund)  
Tax TreatmentLimited Partnerships and LLCs are pass-through entities and investors will be asked to claim a US tax withholding rate. 
Non-US investors are typically not subject to income tax on capital gains unless the fund is engaged in a U.S. trade or business. 
National Venture Capital Association https://nvca.org/

Delaware Overview

In the United States, Delaware is a commonly used jurisdiction to set up a venture capital fund due to the state’s business friendly laws. In addition to having pro-business laws Delaware also has a long history of court precedents, which makes it an appealing jurisdiction to form entities. For funds in particular, Delaware law offers a “clean slate upon which managers can build an entity that works”. Because of this, many fund managers opt for a Delaware fund structure and there are many reputable service providers that can handle setting up a Delaware fund structure efficiently. Funds formed in Delaware are typically formed as Limited Partnerships (LP) or Limited Liability Companies (LLC) (though this is less common). Delaware LPs and LLCs are both pass through entities for tax purposes, which means gains and losses flow through to the underlying investors. 

Delaware LPs must be formed by the fund’s General Partner, which is typically a Delaware LLC. US-based funds are also required to have a management company that acts as the investment adviser to the fund. The management company is also typically structured as a Delaware LLC. 

Investment funds are regulated by the Securities and Exchange Commissions (SEC) and are required to be registered with the SEC. However, VC funds can claim certain exemptions to get around these registration requirements. 

If you are fundraising primarily in the US and investing in the US, setting up a fund in Delaware could be a good option. However, if you are primarily fundraising and investing outside of the US, you may be interested in exploring other jurisdictions. Below is a list of non-US countries that are often used as fund domiciles. Again, this is not an exhaustive list, however the countries listed below are highlighted as potential alternatives to Delaware.

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Fund Domicile – Cayman Islands

Cayman Islands Summary

Fund Structure Exempted Limited Partnership
CostUS$1220 to form the ELP
Annual registration fees
Audited financial statements to file with CIMA
Since ongoing compliance is onerous, most funds engage a service provider to fulfill the fund’s compliance requirements. Costs for these services can be high. 
TimingConfirmation of registration can take ~2-4 weeks to receive
Fund Marketing Marketing documents are not required, however if the fund has marketing materials then they must be registered with CIMA to ensure compliance with Rule on Contents of Marketing Material
Tax TreatmentTax neutral – neither an ELP nor any partner is subject to any form of direct taxation in the Cayman Islands

Cayman Islands Overview

For decades, the Cayman Islands have been one of the leading domiciles for investment funds due to the political and economic stability of the area, the existing solid legal infrastructure, tax neutrality, and copious amounts of expertise in the investment fund space. One notable difference between Delaware and the Cayman Islands with respect to forming your venture fund is the way laws work in each jurisdiction. In Delaware, the Delaware Limited Partnership Law thoroughly outlines the rights and remedies in its provisions. In Cayman, the Cayman Islands Exempted Limited Partnership Law presumes that where the regulation is silent, the fund’s agreement shall control. Cayman funds are typically formed as an Exempted Limited Partnership (ELP). An ELP is not a distinct entity from its underlying owners and does not have a separate legal personality and neither the ELP nor any underlying investors are subjected to taxation in the Cayman Islands. Fund managers can opt for a fully Cayman fund structure or a hybrid structure (usually a Delaware General Partner with a Cayman ELP). 

In February 2020, the Cayman Islands enacted the Private Funds Law 2020 in an attempt to shed its “tax haven” moniker. Doing so has imposed stricter and more onerous compliance measures on fund managers. Fund managers are now required to register with the Cayman Islands Monetary Authority (CIMA) and also face ongoing operating obligations that include implementing a compliance regime for the fund and an annual fee payable to CIMA. Cayman also has stricter KYC regulations, which results in more work for investors to subscribe to a fund. 

The Private Funds Act does not require a venture capital fund to have an offering document or other marketing materials, however if there are marketing materials for the fund to solicit investments, the marketing materials must be filed with CIMA. CIMA’s Rule on Contents of Marketing Material requires detailed disclosures be provided to prospective investors. As such, fund managers who wish to domicile their fund in the Cayman Islands should seek the advice of counsel before providing prospective investors with any marketing materials. 

It is worth noting that many investors are not comfortable investing in a Cayman domiciled fund. The Cayman Islands was blacklisted by the EU Council in February 2020 for being a noncooperative jurisdiction in tax matters. The EU Council subsequently removed Cayman from its blacklist in October 2020 given the tax reforms instituted by the Cayman Islands. Despite this, some prospective investors may still have reputational concerns about investing in funds formed in the Cayman Islands. Another consideration is that FIRRMA regulations may lead some US investors to opt for Delaware over Caymans to have easier access to US mega-tech deal flow.

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Fund Domicile – Ontario, Canada

Ontario, Canada Summary

Fund Structure Limited Partnership
Cost$210 for the initial registration fee and renewal fee
$360 late renewal fee
Formation can become costly depending on the law firm or tax advisor engaged
TimingImmediate turn-around if filed in person
~20 business days if filed by mail
Fund Marketing Funds offering securities to the public in Ontario are required to file a prospectus with the OSC. Once the fund becomes a reporting issuer, there are ongoing reporting obligations. In some instances a fund may not be required to file a prospectus with the OSC.  
Tax TreatmentLimited Partnerships are tax transparent so capital gains flow through to the underlying investors. Residents are subject to tax. Non-residents are not subject to withholding tax on profits. 
Canadian Venture Capital & Private Equity Association https://www.cvca.ca/

Ontario, Canada Overview

The venture capital ecosystem in Canada is growing and since 2013 more than CAD$185B has been invested in over 4000 Canadian companies. Q1 2021 was the strongest quarter on record with CAD$2.7B invested across the following sectors: information, communications, and technology (ICT), life sciences, and clean tech. VC activity is centered in urban areas that also have strong tech sectors, however this report will focus on Ontario as Ontario has the majority of registered venture funds compared to the other provinces. Funds formed in Ontario are mostly structured as limited partnerships. Gains and losses flow through to underlying owners. Fund managers can opt for a fully Canadian fund structure or a hybrid structure if they are located outside of Canada. 

The benefits of domiciling a fund in Ontario include effective and efficient tax codes, reliable government, and a growing startup ecosystem. In addition, compared to jurisdictions like the Cayman Islands, Ontario has less onerous KYC requirements for investors. Anecdotally, there is an interest from fund managers in LatAm in forming their funds in Ontario given the business friendly regulations and that investors are comfortable investing in a Canadian domiciled fund (i.e. there are no reputational concerns as with Cayman funds). 

Fund offerings made to the public in Ontario require that the fund’s prospectus be registered with the Ontario Securities Commission (OSC) however, venture capital funds may be able to rely on exemptions that preclude them from government registration. VC funds typically rely on the accredited investor exemption and the minimum amount investment exemption. Note the accredited investor definition in Ontario differs from definition in the United States. In addition, if an offering is being made to investors in another province, the fund may be subject to the securities laws of the other province. 

Limited Partnerships are tax transparent so capital gains flow through to the underlying investors. Capital gains may be taxed in Canada if such gains result from business carried out in Canada. Resident taxpayers are subject to Canadian tax, but non-residents are not subject to withholding tax on the profits received from the fund. 

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Fund Domicile – Singapore

Singapore Summary

Fund Structure Singapore Limited Partnership
CostS$115 for 1-year registration
S$175 for 3-year registration
S$30 for a renewal fee
S$60 for amendments
Formation can become costly depending on the law firm or tax advisor engaged
There is a S$1,000 non-refundable application fee and S$4,000 annual corporate fee for a Venture Capital Fund Manager license
TimingEntity registration can be completed in 1 day, but it can take up to 2 months in unusual circumstances if the application requires additional governmental review
Fund Marketing Register the fund offering with MAS 
Tax TreatmentOne-tier corporate tax system so once corporate income tax is paid by a Singaporean tax-resident company, shareholders are not taxed on dividends
No capital gains tax devised the disposal of capital investments
Gains from the disposal of ordinary share are tax exempt if certain standards are met
Singapore Venture Capital & Private Equity Association https://www.svca.org.sg/

Singapore Overview

Singapore is a leading global domicile for venture capital funds. In 2019, Singapore authorised 45 new VC funds to operate under the Venture Capital Fund Manager (VCFM) regime. Tech companies are driving most of the new investment, and key sectors are fintech, manufacturing, eCommerce, and biotech. The government is promoting innovation and trying to establish itself as a regional and global leader in the venture space, so regulations are typically pro-funds. Venture funds are typically structured as limited partnerships. Limited partnerships in Singapore do not have a separate legal personality and investors are not personally liable for debts or obligations beyond their capital commitment to the fund provided the investor is not involved in the management of the fund. Note that obtaining a VCFM license is a 2-3 month process in most cases. In order to receive approval for the license, the Monetary Authority of Singapore (MAS) requires funds to have at least two full-time employees in Singapore and a physical office there. Foreign workers would need to apply for employment passes.

There are prospectus and registration requirements in Singapore related to the offering of fund interests to investors located in Singapore, though a venture fund may rely on an exemption from registration. Typically, an offer to sell securities must be registered with MAS. If the fund is a collective investment scheme, the fund must be approved by MAS. Note this applies to both funds organized in Singapore and outside of Singapore. You should consult legal counsel if you have any questions related to offering securities in foreign jurisdictions to ensure you are complying with local fund marketing regulations.

There are several tax incentive schemes that venture funds may qualify for. For example, funds that have the necessary approvals and licenses from MAS and commit to investing a certain percentage of capital in Singapore based companies may qualify for the Section 13H tax incentive. Funds approved for this tax incentive are exempt from certain taxes for up to 15 years on specified income from certain types of investments that include but are not limited to gains from the divestment of portfolio holdings and dividend income from foreign portfolio companies. The Section 13R tax incentive is another popular scheme for venture funds that exempts them from specified income on designated investments. In order to be eligible for the Section 13R tax incentive, venture funds are required to use a Singapore-based fund administrator, and there is a minimum required annual business spend of S$200,000.

Singapore’s access to the fast-growing markets in APAC and its well-developed infrastructure has  made it an attractive jurisdiction to domicile funds in the region. Singapore and Mauritius (see below) are both attractive jurisdictions for funds investing in India. In 2020, over 950 foreign portfolio investors registered in Mauritius and Singapore managed more than $100B in assets under custody in India. 

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