Most legal jurisdictions around the world have legal entity requirements or recommendations for venture capital business. Therefore, most institutions engaged in venture capital business will establish a legal entity in the local legal jurisdiction. Below are several legal entities that often appear in the investment world. You can also check the official website of the US Small Business Administration (SBA) to learn more types of business entities.
Partnerships
Partnerships are structures in which two or more people own a business together. There are three common types of Partnerships: general partnership (GP), limited partnership (LP) and limited liability partnership (LLP). Since limited liability partnerships (LLPs) can only be established by certain types of professional services firms, such as accountants, lawyers, architects, dentists, doctors, and others who are considered professionals under state laws, there is no such thing as a limited liability partnership (LLP) in the VC world. It is not common, so we only introduce the two forms of partnership: general partnership and limited partnership.
General Partnerships
General Partnerships (GP) are two or more people who share the management and personal responsibilities of a business. This is the simplest structure you can choose when starting a business with one or more partners. Setting up a general partnership is as simple as registering a name, obtaining an EIN number, and creating and signing a partnership agreement. Because GP does not need to register with the state, has low operating costs, and does not need to pay establishment application fees and franchise taxes, GP has been used by tens of thousands of investment clubs.
In a general partnership, all partners are personally liable for the debts and obligations of the business. Each partner in a general partnership is responsible for the actions of the other partners. A general partnership is the easiest to establish and has the lowest ongoing operating costs, but the personal risks borne by the Partner are higher.
Limited Partnerships
Limited Partnerships (LP) are the most common legal entities in the field of venture capital, and most funds use limited partnerships as their legal entities. We can quickly understand what a limited partnership is through the responsibilities and responsibilities of the partner role in the actual business of venture capital.
Limited Partner (LP): These partners are investors who provide funds to the fund, so they are also called investors in the fund. Limited partners do not participate in the day-to-day management and operation of the fund. Their liability is limited to the amount of their investment in the fund, that is, limited partners have limited liability. This means that once the fund faces compensation, bankruptcy or litigation, limited partners only need to bear relevant liabilities within the proportion of their investment.
General Partner (GP): GP is usually an institution or natural person that manages a fund. General partners are responsible for investment decisions, managing portfolio companies, and working hard to generate returns, so they are also called venture capitalists or venture capitalists (Venture Capitalists). Unlike limited partners, general partners have unlimited liability.
Usually, the general partner will sign a Limited Partnership Agreement (LPA) legal file with the limited partner to stipulate in detail the relationship and terms between the two, including management fees, share rights, fund term and other detail. In addition, regulations vary from jurisdiction to jurisdiction. If you plan to establish or join a fund that uses a limited partnership as a legal entity, it is recommended to consult the relevant authorities in your local jurisdiction.
Limited Liability Company
There are many reasons to form an LLC rather than a partnership, including liability, ownership roles, and more. Most importantly, LLCs offer business owners the benefits of corporate and partnership structures. This makes the LLC an excellent business structure for medium- and high-risk businesses, as owners with significant personal assets are protected.
A limited liability company has the following characteristics:
Limited Liability: The owners (or members) of an LLC are protected from personal liability for the actions of the LLC and other members.
Greater flexibility: Members of an LLC can be individuals, partnerships, trusts or corporations, with no limit on the number of members. An LLC may also decide to have its members manage day-to-day operations (member-managed), or these duties may be performed by non-members (manager-managed).
Increased credibility: LLCs can help new businesses establish credibility more effectively than general partnerships.
In the investment field, a powerful Investment Club may adopt an LLC as its legal entity, which can better protect the personal property of each member. In addition, in a fund executed based on a limited partnership (LP), if an institution assumes the role of General Partner, the GP will usually adopt an LLC as its legal entity. In addition to being very flexible in management, using an LLC as a legal entity can also protect the personal assets of the fund manager from being exposed to risks due to the fund's debts or lawsuits to a certain extent.
The disadvantages of forming a limited liability partnership or LLC are that they are more expensive to form and operate than a partnership, requiring organizational fees and ongoing expenses, the need for an attorney to draft articles of organization, and more.
SPV
Special Purpose Vehicle (SPV for short) is usually an independent entity established by the parent company for a specific special purpose, also known as a special purpose entity (SPE). An SPV allows multiple investors to pool their funds and invest in a company. An SPV is an entity structure design that can be set up as a limited partnership (LP) or a limited liability company (LLC). It should be noted that, usually, the SPV is a concept relative to the parent company, that is, the SPV is usually an independent entity spun off from the parent company.
SPVs are also often used in venture capital. SPV can help funds or venture capital companies achieve more flexible investment operations. For example, when a specific investment project is inconsistent with the investment philosophy of the fund or investment company, limited partners or company members can voluntarily choose whether to join the SPV. In addition, isolating a specific start-up investment within an SPV can also protect the investment from the risks posed by other investments held by funds or venture capital firms. The SPV is a very flexible and practical tool for investment funds and investment companies.
The biggest difference between SPVs and traditional venture funds is that SPVs invest all of their capital in one company. Traditional venture capital funds or investment companies invest in companies in multiple stages and industries that fit the fund's investment theme. Additionally, traditional venture capital funds or investment companies are long-term investments and it may take them up to 10 years to exit every investment in their portfolio. In contrast, SPVs typically seek to return funds to investors in a shorter time frame, as realizing returns is solely dependent on a company's exit, such as an acquisition or IPO.
DAO
DAO is a decentralized autonomous organization. You can simply understand it as a type of organization based on code execution.
In recent years, with the rise of blockchain technology and the Crypto concept, many funds have begun to try to use DAO tools to establish and execute an on-chain fund. Compared with the traditional fund execution model, DAO has demonstrated its advantages in many aspects, such as:
Funds managed in smart contracts make investors' funds more secure and at the same time enlarge the trustworthy boundaries of fund financing.
Partnership agreements and fund rules that are automatically executed based on smart contracts make the interests of investors more secure and reduce the operation and management costs of the fund.
Obviously, the advantages of DAO are far more than this, but we will not go into details here. We will write a separate article to introduce it.
The legal status of a DAO may vary across the jurisdictions in which it operates. Currently, some jurisdictions may recognize DAOs as legal entities, while other jurisdictions may not have regulations or laws specifically targeting DAOs. Therefore, if you intend to establish or participate in a fund executed through a DAO, it is recommended to consult the relevant authorities in your local jurisdiction.
However, a trend we see is that more and more countries and regions are trying to embrace this emerging thing, such as Ohio, Switzerland, Singapore, Estonia, Malta, Marshall, etc. in the United States. As Crypto gains support from more legal jurisdictions, DAOs are likely to become an emerging category of entities driven by technology.
Summarize
General Partnership (GP): Two or more people share management and personal responsibility for a business, the simplest structure that partners can choose when starting a business. Due to its simplicity and low cost, it is adopted by most investment clubs in the United States.
Limited partnership (LP): consists of two roles: general partners and limited partners. The most common legal entity in the field of venture capital, most funds use limited partnerships as their legal entities.
Limited Liability Company (LLC): The owners (or members) of an LLC are protected from personal liability for the actions of the LLC and other members. A strong Investment Club may adopt an LLC as its legal entity. The General Partner in a limited partnership (LP) will also often adopt an LLC as its legal entity.
SPV: An SPV allows multiple investors to pool their funds and invest in a company. An SPV is an entity structure design that can be set up as a limited partnership (LP) or a limited liability company (LLC). The biggest difference between SPV and traditional venture funds is that SPV invests all its capital in one company and has a short exit time.
DAO: DAO is an organization type based on code execution. DAO has many advantages over traditional entities and is likely to become an emerging category of entities driven by technology.
