CONTRIBUTED BY
Asher Bearman
asher.bearman@dlapiper.com
This installment of how VC funds work illustrates a basic offshore venture capital fund structure for a fund that will make investments predominantly outside of the US (for example, China). Typically, we form these type of funds in the Cayman Islands due to its similarity with Delaware law and for tax planning purposes.
Obviously, there’s a few more boxes here than in a typical domestic fund, but it’s not all that complicated when you look at the reason for each piece. You can compare the slightly more complicated structure below against my prior chart on a basic US VC fund structure.
Fund: This is the main venture capital fund entity that makes investments in other companies. Not much different from a domestic fund in this structure as Cayman Islands law is highly similar to that of Delaware and is generally familiar to sophisticated fund investors.
Parallel Fund: In some circumstances, the fund may be setup as a couple of funds that invest in parallel into portfolio companies. These may be created for Investment Company Act purposes (such as to create side-by-side funds that qualify under 3(c)(1) and 3(c)(7) of the act, respectively) or to allow the fund manager’s principals and affiliates to invest in the fund on a no-load basis (i.e., with the parallel fund being structured the same as the main fund and making the same investments, but charging no management fee or carried interest). These issues are also often relevant in a foreign fund context where the fund has US investors.
General Partner: This entity is the decision maker for the fund and also receives the carried interest paid by the fund (i.e., 20% of profits in a typical “2 and 20” fund). Usually, successor funds will have their own, new general partner to faciliate potentially different carried interest recipients/allocations. The Cayman Islands don’t allow for limited liability companies, so this is being formed as a limited partnership to allow for the flow of carry and invested capital using the flexibility of a flow-through partnership structure.
Corporate General Partner: Because the GP entity is formed as a partnership in this structure, we add a third tier general partner that is a corporate entity to provide for limited liability to the fund managers of the fund, providing substantially the same protection as what a limited liability company allows a General Partner in Delaware (abeit using two entities instead of one).
Management Company: This is the business of the fund. The management company receives the management fee from the fund and uses it to pay the overhead related to operating the venture firm, such as rent, salaries of employees, etc. Depending on the jurisdiction, there may be subsidiaries of the management company formed in foreign (local) jurisdictions and/or in the US. Note that US branches may alter the fund manager’s qualification for an exemption from the Adviser’s Act (see prior post here).