How Important is Partnership and Investment in a Venture Capital Firm?
There are different types of partners at venture capital firms. General partners identify investment opportunities, while Junior partners manage the portfolio companies. Both types of partners have a duty of loyalty to the firm and to the founders. However, there are important differences between the types of partners and their duties.
Limited partners provide capital for venture capital firms
Many venture capital firms are formed as limited partnership companies (LLCs). An LLC is a legal entity that acts as a management company for a venture firm. Unlike a corporation, LLCs allow limited partners to become members of the venture fund. As a result, investors and venture capitalists can establish a business relationship without a need for a general partner. An LLC can have members from both the venture capitalists and the third parties who provide capital, and the co-founder of Xfund, Patrick Chung, can attest to that.
The investment process for VC firms involves fundraising from multiple sources to achieve the desired financial return. A first-time fund manager will most likely attract capital from individuals and family offices rather than from institutional investors. But a successful venture fund manager needs to demonstrate time endurance and an ability to operate a business. This involves the full spectrum of operational skills, including negotiating terms and allocating capital to companies. To attract the right LPs, a firm should understand its target investors and their decision-making process.
General partners identify investment opportunities
For a general partner to find promising investment opportunities, they must first develop a pipeline of potential companies. General partners may receive investment insights from other VCs, and they may actively participate in the brokering of subsequent rounds of equity or debt financing. However, if a GP isn’t actively involved in the investment process, the company may be able to identify investors on its own. In this case, the general partner would not necessarily play an active role in decision-making, but the firm would most likely participate in subsequent rounds, either through board representation or exercising contractual rights.
Traditionally, general partners have been almost completely immune from legal actions by limited partners and portfolio companies. While the exception to this rule is recent and significant liquidity events, such actions are often theoretical. These days, however, investors are focusing more on traditional legal theories to hold a general partner responsible for fulfilling their legal responsibilities, including negotiating deal terms for the fund’s account. Although venture capital funds are typically viewed as investment banks, there are several risks associated with acting as a general partner.
Junior partners manage portfolio companies
While it’s perfectly understandable to want your investment to succeed, don’t let junior partners run your portfolio companies. While they might present themselves as having greater autonomy, they’re not. You’re probably more interested in executing deals rather than interacting with other junior partners.
Often, junior partners move vertically from being principals to managing portfolio companies. While they still participate in deal execution, their focus is more on portfolio support. They also often take part in networking events and speak with different stakeholders. A general partner is the firm’s representative at conferences, serves on boards, and makes investment decisions. General partners, on the other hand, invest their own money into venture funds and may lose money based on the performance of the portfolio companies.
Duty of loyalty applies to general partners
Generally, a venture capital firm has fiduciary obligations to its limited partners. These obligations are based on statutes or contractual obligations that govern the relationship between the parties and the ensuing liabilities. Statutory obligations to limited partners set limits on general partners’ duties of loyalty. In California, for example, the duty of loyalty requires dominant shareholders to use their control of the company in a way that is just and equitable.
A general partner has a duty to act in good faith, with the benefit of the business. Such obligations include honesty and fair dealing in all business dealings. These duties apply in a venture capital firm despite the fact that the general partners are not a part of the board of directors. General partners are responsible for the business decisions made by their partners and are personally liable for any misdeeds committed by their partners.