How VC Funds Work – Structure Chart

for Venture Capital Fund (Non-US Fund)

By Asher Bearman on June 1, 2011Posted in Investors

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).