Part 1: Demystifying the Fund Formation Legal Process for EMVCs
In this 3-part series on venture fund formation and legal strategies, we will share an overview of the legal documents required for fund formation and discuss which elements are standard or open for negotiation and customization with input from the knowledgeable minds at Wilson Sonsini Goodrich & Rosati. Among the highlights of crafting The Venture Fund Blueprint is the privilege of engaging with each one of you, receiving inbound queries, reactions, and perspectives about establishing a premier venture firm grounded in operational excellence. A considerable portion of the discussions we foster centers on nuances of fund formation and legal intricacies, elements that form the critical and foundational cornerstones of building and growing a successful fund, such as this series with all the documents required for venture capital fund formation.
In this first segment, we will 1) outline all of the basic legal documents required for fund formation, 2) mention which documents are often negotiated (to be covered in greater detail in subsequent posts), and 3) share a selection of sample documentation for reference. Please note that this information is specifically for emerging managers in venture capital, most lawyers prefer to use their own forms, Growth Vista Ventures is a fictional entity for purposes of this post, and the following list assumes venture capital fund formation of a Delaware limited partnership as the fund and Delaware limited liability company as the general partner.
Certificate of Formation for General Partner, LLC - An LLC (“Limited Liability Company”) often serves as the General Partner (“GP”) of the fund, and the Certificate of Formation is a critical document associated with the creation of this LLC. Without it, the GP LLC does not have a legal existence in the state of formation. The Certificate of Formation typically includes fundamental details about the GP LLC, such as its name, the name and address of its registered agent, and the purpose of the LLC. Its purpose is Liability Protection, as one of the reasons an LLC structure is chosen for the GP is to offer liability protection to its members, and, by formally establishing the LLC, members of the GP (which could be individuals or other entities) are generally not personally liable for the LLC's debts or liabilities. The document is standard, often handled by a paralegal, and filed in Delaware: Link to sample.
Initial LLC Operating Agreement - The Initial LLC Operating Agreement is important in establishing the firm and simply needs to be put in place. It is required by banks and fund administrators to establish a working relationship with them. The document is foundational, standard, internal, and often handled by a paralegal: Link to sample.
Certificate of Limited Partnership for Fund - The Certificate of Limited Partnership for Fund (“CLP”) brings the venture capital fund limited partnership into legal existence. Until this certificate is filed and accepted by the state of formation, the partnership does not legally exist. The CLP may be handled by a paralegal, and this formation of entity is typically filed in Delaware, which is the typical state of jurisdiction for venture capital funds. The terms of this document are set and not open for negotiation: Link to sample.
Initial Limited Partnership Agreement - The Initial Limited Partnership Agreement (“ILPA”) acts as a stepping stone in the venture capital fund formation process to establish the basic legal agreement between the GP and the initial LP, from which the more detailed and final Limited Partnership Agreement (“LPA”) will be crafted. The ILPA typically outlines the fundamental terms of the partnership, including the identity and authority of the GP and the initial limited partner (“LP”), the fund's purpose, and initial capital contributions. This document is often handled by a paralegal and is often necessary to open a bank account. ILPA is generally an internal document that LPs do not request a copy of and no one negotiates. Under Delaware LP law, there must be an LPA in place at all times that has at least one LP and one GP. The initial LP is an internal person; pick one fund manager (lawyers prefer to use one person whenever possible) as GP and LP to sign, initially hold all the rights until the LPA is amended and restated, and then withdraw as LP when you have an actual LPA in place. Typically the ILPA is prepared and signed immediately after the CLP. It is common to see “Amended and Restated” on the top of these filings. The first filing is often disregarded, once the LPA is in place: Link to sample.
Non-Disclosure Agreement/Data Room Non-Disclosure Agreement - The Non-Disclosure Agreement or Data Room Non-Disclosure Agreement (“NDA”) is a confidentiality agreement related to accessing a virtual data room where sensitive documents about the fund are stored. Whether or not to have a data room is a separate discussion. While it is a judgment call whether or not to use an NDA, it may be easier to have a form available. This document is optional: Link to sample.
Deck Disclaimer - While a venture capital fund’s pitch deck is not itself a legal document, the deck usually includes a deck disclaimer, which is. The Deck Disclaimer is a legal notice that serves to limit the liability of the GP(s) and provide specific notices to prospective investors, including disclaimer of confidential info, assertion that the pitch deck is not an offering of securities, disclaimer regarding forward-looking statements that may not come true, clarification if fund managers have not worked together before, and reminder to only rely upon real the LPA once issued. Though technically optional, it is best practice to include it in the pitch deck and to position it at the beginning of the presentation. Another best practice is to request legal counsel to review the actual pitch deck, even though not a legal document, to verify that there are no unsubstantiated claims or terms to cause fund managers in legal jeopardy, such as promises like “we will earn 15% IRR,” or Securities & Exchange Commission (“SEC”) violations: Link to sample.
Private Placement Memorandum - The Private Placement Memorandum (“PPM”) is a legal document provided to LPs when raising capital. This document describes the fund’s investment strategy, differentiation, deal sourcing, deal evaluation; business thesis; industry; expected exit opportunities; term sheet; and everything from the risk factor disclosure packet (the back half of PPM), including international and state legends, contract for fund admin, lawyer, and other service providers. If the PPM is for a Fund II or beyond, the PPM often includes sample deals with one pagers on prior deals to highlight, as illustrative for prospective LPs. This document ranges from 50 to more than 100 pages and may be longer for VC firms with long histories. A PPM is often not used for venture capital funds with emerging managers (<$250mm). Even with Form Reg D, the PPM does not meet the S1 filing standards. For larger VC firms, many create PPMs in case of an LP request.
Term Sheet - The Term Sheet is a summary of material terms of the LP Agreement of the fund. There is no legal requirement to have this document and most LPs never ask to see one. The benefit of creating one is that it can act as a summary of the full length LP Agreement and can be given to LPs who prefer not to read the full document. If there is intent to do a PPM, a Term Sheet is always part of PPM; if there is intent to do a deck and not a PPM, a Term Sheet may be delivered with the deck. It may be easier to have a discussion with an attorney about the terms of agreement in advance from the starting point of the term sheet and lead to an easier time with LPA in future. This document is optional and a matter of personal preference: Link to sample.
Risk Factor Disclosures - Risk Factor Disclosures are a section of offering documents, commonly known as the PPM, where potential risks associated with investing in the fund are explicitly outlined, such as general economic uncertainties to more specific risks inherent in the fund's investment strategy. By providing a comprehensive overview of potential risks, the disclosures ensure that LPs are fully informed about the challenges and uncertainties they might face when investing in the fund. By clearly articulating risks, GPs can protect themselves from potential legal claims by LPs who might later argue they were not adequately informed about the risks of the investment. Proper disclosure of risks is a best practice for funds that are raising capital and sometimes are required under securities law. Clearly outlined risk factors can set the right expectations for LPs, ensuring that they understand both the potential rewards and risks associated with their investment. While optional, Risk Factor Disclosures are sometimes included in short form in the SA, if there is no PPM; if there is a PPM, this information is often covered therein. While not commonly read, it is a precautionary measure that includes conflicts of interest.
Expression of Interest in Investing - The Expression of Interest in Investing (“EOI”) is an indication that an LP is considering an investment in a fund. An EOI is typically non-binding, acting as a show of interest rather than a commitment to invest, and can be used as an intermediary step in between soft circled commitments and actually signing subscription agreements and wiring money. While some fund managers request an EOI and may utilize it in hopes of moving a prospective LP from a “maybe” to a “yes” because it requires putting pen to paper and going through the exercise of “Subject to all these conditions, I intend to invest $x,” it is not proven to be more effective. This document is optional: Link to sample.
Subscription Agreement - A Subscription Agreement (“SA”) is a legal document that outlines the terms and conditions under which an LP agrees to make a capital commitment to a venture capital fund; makes representations, warranties, and covenants to the GP and the fund; and completes an investor questionnaire. The SA is the primary document where an LP formally makes a capital commitment to the venture capital fund. It solidifies the LPs obligation to comply with the terms and conditions of the LPA, including the obligation to make capital contributions. For GP, the agreement provides legal assurance that the LP will adhere to its commitment. In terms of process, the LP signs, the GP countersigns once the requisite conditions are met to close, and the SA is returned to the LP with the fully executed LPA. Some SAs include a Power of Attorney that grants the GP the authority to sign the LPA on the LP’s behalf. This document is required and generally not negotiated: Link to sample.
Limited Partnership Agreement - The Limited Partnership Agreement (“LPA”) is one of the more important of the legal documents and is really an amended and restated ILPA (see #4). This vital, foundational document provides a contract between the GP and the LPs that distinctly outlines the terms of their relationship, the operation and governance of the fund, and the rights, obligations, preferences, and privileges. The LPA details how rights work, how economics work, how voting works, and how the GP manages the fund. It is highly technical and can range in length from 50 to well over 100 pages. The LPA is a critical document that will be prepared by head legal counsel, and there are many items to negotiate there-in. We will share a sample and delve into the LPA in detail in segment #2 of this 3-part series.
Closing Checklist - The Closing Checklist is a comprehensive list detailing all the essential documents, actions, and verifications needed to successfully close the establishment or a specific fundraising round of a venture capital fund. It starts from basic formation to closing of the fund with all of the tasks that need to be accomplished with a responsible party designated for each. This document is optional but can be helpful to show, if a fund wants to know all of the steps: Link to sample.
In the next two segments of this 3-part series, we will cover the LPA and Operating Agreements, providing samples and delving into key negotiation terms for each.
Navigating the intricate maze of venture capital fund formation demands an intimate understanding of its foundational legal documents. Each one plays a pivotal role in ensuring transparency, compliance, and the smooth operation of the fund. As emerging managers, mastering these documents is more than just a bureaucratic necessity; it is the bedrock upon which successful funds are built. By demystifying these essential tools, we empower fund founders to forge ahead confidently, creating robust and resilient venture capital initiatives for the future.
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Disclaimer: The information contained herein is based on a fictitious entity and must not be construed as legal advice or a representation of any actual, existing entity, organization, or individual. The providers, companies, examples, products, and services shared represent only a subset of available options and are based solely on internal fund manager conversations. These options are intended to be a general framework, not an exhaustive catalog, and should not be viewed as legal or tax advice, endorsements, recommendations, approvals, or rankings. We encourage you to do additional research into each category to find the resources that best fit your specific needs.
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Sincere appreciation to our contributing author Jim Jensen, Partner at Wilson Sonsini Goodrich & Rosati, along with Shea Tate-Di Donna and Kaego Ogbechie Rust, authors of The Venture Fund Blueprint.
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