Part 1: Mastering Venture Fund Expenses - From Policies to Reporting

Welcome to the latest edition of The Venture Fund Blueprint newsletter, where we delve into the intricacies of building a top-tier venture firm grounded in operational excellence. Your engagement and insightful questions fuel our content.

In this 2-part series, we turn our focus to a topic high on your query list: venture fund expense policies. This piece will cover expense policies, approval processes, and reporting; our second piece will cover fund expenses, management company expenses, and business vs. personal expenses. Guided by insights from the knowledgeable minds at Andersen and Morris Accounting & Advisory, we are excited to unfold the complexities of fund expense rules and share essential information, especially tailored for emerging venture capital fund managers.

Question #1: Should my fund have an expense policy?

Absolutely. An expense policy is essential for a venture capital fund for several reasons:

• Guidelines & Transparency - An expense policy establishes clear guidelines for fund expenditures, enhancing transparency with limited partners and investors and fostering trust and open communication within the fund.

• Legal & Industry Compliance - The expense policy ensures that the fund is operating within legal boundaries, mitigating risks of legal complications and adhering to industry standards and best practices, which are crucial for long-term sustainability.

• Tax Compliance - It ensures compliance with federal tax rules and regulations, particularly concerning deductibility and substantiation of expenses.

• Optimizing Fund Performance - The policy guides fund managers in allocating resources effectively, directing funds towards activities that yield higher returns, and contributing to the overall efficiency and success of fund operations.

This structured approach to managing expenses is integral to the operational excellence of any venture capital fund.

Question #2: What should the expense approval process look like?

Establishing a consistent expense approval process is key to effective internal controls with the following three key elements:

1. Implement Approval Thresholds - While we see a variety of approval thresholds and processes across the industry, the most important thing is to choose a policy and apply it consistently. An example of an ideal process is a) Any Partner (or a designated employee such as a CFO) may approve and/or pay invoices on behalf of the management company/ fund up to $1,500, and b) Invoices that exceed $1,500 must be approved by a second Partner.

2. Utilize Third Party Resources - Engaging a third-party provider for Accounts Payable processing adds an extra layer of oversight, which is often appreciated by Limited Partners (LPs) and can be managed by the fund administrator or your management company accountant. Tools like Bill.com or Melio are recommended for tracking approvals and streamlining payments.

3. Set Credit Cards & Expense Reimbursement - Establish best practices around credit card usage and expense reimbursement, including preparation of monthly expense reports for each cardholder and required approval by someone other than the cardholder. These reports should detail transaction date, amount, purpose, receipt, and attendees for meals and events, if applicable. For expenses over $75, separate receipts are advised, although electronic receipts (credit card statements) are generally acceptable for business-only expenses. Systems like Expensify or Tallie can be helpful in tracking and ensuring policy compliance.

In summary, establishing a consistent expense approval process with clear approval thresholds, utilizing third-party resources for oversight, and setting structured practices for credit card and expense reimbursement are crucial steps in ensuring effective internal control and financial management in your organization.

Question #3: What are my reporting requirements for fund expenses?

Fund Reporting

Fund financial statements are generally required to be prepared in accordance with Generally Accepted Accounting Principles (GAAP). It is common for funds to hire a fund administrator for preparation of these materials and for the fund to require an annual audit by an independent Certified Public Accountant (CPA). There are exceptions to the requirements depending on the investor base. Requirements for your fund will be specified in the Limited Partnership Agreement (LPA).  Fund financials (Balance Sheet, Schedule of Investments, Income Statement, and Partners Capital Account Statements) are typically prepared on a quarterly basis and distributed to Limited Partners. The annual reporting package also includes an opinion from the auditor, a statement of Cash Flows, and accompanying footnotes to the financial statements.

Summary:

• Financial Statements - Prepared in accordance with GAAP, typically by a fund administrator

• Annual Audit - Conducted by an independent CPA, with requirements detailed in the LPA

• Quarterly Reports - Include Balance Sheet, Schedule of Investments, Income Statement, and Partners Capital Account Statements, distributed to Limited Partners

• Annual Reporting Package - Features an auditor's opinion, a statement of Cash Flows, and detailed financial statement footnotes

Management Company Reporting

Management company books are generally prepared for the purposes of managerial decision making, reporting income taxes, and loan compliance. There is more flexibility in the management company reporting, though typically monthly reporting is comprised of the following:

• Balance Sheet

• Income Statement

• General Ledger

• Budget to Actuals

It is recommended that fund managers prepare an annual budget for the management company operating expenses, typically in coordination with the fund’s administrator or management company accountant to help facilitate the process with routine recurring expenditures. Spend, however, is a strategic business decision, and many assumptions must be prepared with the support of the General Partner(s) (GPs). For smaller entities, budgets may be treated as a useful and flexible tracking tool, rather than a strict guideline. As organizations and operations grow, applying and enforcing strict budgets becomes more important.

Summary:

• Flexible Reporting - Aimed at decision-making, tax reporting, and loan compliance

• Typical Monthly Reports - Balance Sheet, Income Statement, General Ledger, Budget to Actuals

• Annual Budget - Recommended for strategic planning, especially for smaller entities; stricter budget adherence becomes crucial as the company grows

This approach ensures compliance and transparency in financial reporting for both the fund and the management company.

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Sincere appreciation to our co-authors John Griffin, Managing Director at Andersen, and Jennifer Morris, CPA at Morris Accounting & Advisory, along with Shea Tate-Di Donna and Kaego Ogbechie Rust, authors of The Venture Fund Blueprint.

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Disclaimer: 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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Disclaimer: The opinions and analyses expressed herein subject to change at any time and are solely of the individual expressing them. Any suggestions contained herein are general, and do not take into account an individual’s or entity’s specific circumstances or applicable governing law, which may vary from jurisdiction to jurisdiction and be subject to change. No warranty or representation, express or implied, is made by the author, nor does the author accept any liability with respect to the information and data set forth herein. Distribution hereof does not constitute legal, tax, accounting, investment or other professional advice. Recipients should consult their professional advisors prior to acting on the information set forth herein. © 2023 Andersen Tax LLC. All rights reserved.