Note: This article is the twelfth in an ongoing series on venture fund formation and management. To learn more about managing a fund, download this free eBook today Venture Capital: A Practical Guide or purchase a hard copy desk reference at Amazon.com.
In Part I of this article we discussed the major topics covered by the legal documents that set up a venture fund. In Part II we addressed the limitations placed on investors in funds, governance standards and key accounting issues. Now let's talk about how to find good legal and accounting services and what tools you will need to manage your fund efficiently and successfully.
Do you have any advice on how to find good legal and accounting services for a new fund manager? And, what do you think is a reasonable range in costs for these services?
You want experienced lawyers. But the key to selecting good lawyers is to understand exactly what it means to “be experienced”. This is more than just a question of whether they are the right kind of lawyer: a corporate lawyer, as opposed to, say, an environmental lawyer. To be good and efficient at your transaction, they have to have actually done this exact type of transaction before. Otherwise you are going to be paying them to learn on your dime as they go along. And, more importantly, lawyers unfamiliar with this kind of transaction are inevitably going to miss issues that should have been spotted when “a stitch in time could save nine”. In a perfect world, they would have done this kind of transaction for the same “side” in the past: representing the licensor of software is different than the licensee; representing the buyer of a company is different than representing the seller. So if you can have your pick of lawyers, you are looking for someone who has formed funds like this for GPs like you in the past. You want to make sure they work closely with a team of tax law specialists to ensure their document templates (and any changes you request) are up to spec with respect to current tax rules.
The legal cost of setting up a fund can range anywhere from $10,000 to $100,000 depending on the size, complexity, degree of customization and the city in which you are doing it (big city law practices tend to have more specialized expertise, but also higher hourly billing rates). Keep in mind, however, that trying to economize by seeking out lower billing rates may not actually save you money in the long run. Often the more expensive, but deeply experienced and very time-efficient senior practitioner is going to end up being cheaper in terms of doing the initial work more efficiently. And, their expertise may save you mistakes which end up being very costly down the road.
Finding good accounting help is somewhat easier because the work involves reasonably straightforward partnership and LLC pass-through taxation issues with which most decent-sized practices will be familiar. But here as well, paying for experience can save you money. More experienced partners have seen the traps and pitfalls before and can anticipate the key issues and help you plan for them. And keep in mind that a very big part of your cost is going to be up front in getting the tax and accounting practitioners up to speed on the terms and details of your fund and getting the fund data (such as holdings, allocations and LP addresses) loaded into their system. So you want to pick a good quality firm with a long-standing reputation and a relatively deep bench of talent. Outgrowing your firm or having to switch due to performance issues will require you to incur the start-up costs all over again. In terms of annual fees, again it will depend on the size and complexity of your fund (including the number of LPs), but you are looking at a range of about $2,500 per year to as much as $15,000 per year for more complex funds.
One budgetary planning item worth mentioning is that shutting down your fund at its conclusion is often not a trivial matter. If all your companies are not exited, it may be necessary to amend the operating agreements to extend the length of the fund beyond its original 10 years, which means getting amended papers re-signed by all the LPs. And even then you may find that you have to wind down with as yet un-exited holdings, which can mean finding a buyer for your holdings or distributing the stock to LPs in-kind on a pro-rata basis. Both of these sorts of transactions can be very messy and burn up a lot of time from legal, accounting and tax professionals. Expect shutting down your fund to cost roughly as much as starting it up. And then afterwards there will still be one, or possibly two, trailing tax filings when you are done.
What about the tools you use to manage your venture fund portfolios? Is Excel good enough for venture fund management, or do you have a better solution to take on this challenge?
When I first started investing many years ago, I found Excel to be good enough to manage a small number of investments. As time went by and the size of my portfolio grew, I started to run into a number of portfolio management challenges. I would say that my biggest challenges fell into the following areas:
Portfolio Valuation: Keeping track of convertible notes, warrants and preferred stock, new rounds of financing, etc. made it very difficult to accurately calculate the value of my portfolio and track KPIs (Key Performance Indicators) such as DPI (Distributed to Paid-In) and TVPI (Total Value to Paid-In).
Tax Records: Pulling together all of my prior year transaction records for my accountant became cumbersome and time consuming.
Reporting: Quarterly and Annual Reports for my LPs required days of tedious work, and came at the expense of helping my portfolio companies succeed.
Analysis: Although Excel does have some basic graphing and charting, I didn’t have good visualization tools to help me analyze my portfolio in a convenient dashboard.
Accessibility: I spend much of my time on the road which makes reviewing an Excel spreadsheet on a smartphone very difficult. I needed a tool that was mobile friendly.
To address those challenges, Ham and I decided we needed to move on from Excel. When we researched portfolio management platforms, we found nothing that met our needs. Having spent most of our careers in the software industry, we launched our own startup and set out to build a powerful portfolio management solution to address the challenges of managing and valuing venture investments. Today we use Seraf to track the Launchpad group portfolio, as well as our personal portfolios and all three of the funds we operate. Thousands of angels, VCs, family offices, accelerators and angel groups around the world have joined us, making Seraf the leader in early stage portfolio management.
Although the people who claim venture capital is a totally unregulated business are pretty much correct (even factoring in the SEC’s 2023 reporting rules, the regulation here is very light), this is not the same as saying it is a simple business. Properly designing and running a venture capital fund is actually a fairly complex endeavor that requires mastery over many legal, accounting and tax concepts. With help and advice from experts these concepts can be mastered well enough to get your fund up and running, but even then there will be very significant ongoing accounting, reporting and tax filing work. That is the reality of the VC business. LPs are sophisticated and there is nothing informal about this industry. This reality should not scare away people who believe they are well-suited for the work, but it must be appreciated so that would-be fund managers understand what they are getting themselves into before quitting their day job.