If you’re aspiring to become a VC, you may be familiar with the traditional model: a 2/20 distribution structure, a melange of GPs and LPs that can contribute a diversity of resources, and a streamlined process for the evaluation of portfolio companies. While this model works for many, if not most VCs, you may want to consider a simpler or more complex model depending on your investment thesis. Here, we’ll go over a few alternative investment vehicles.
SPVs
Special purpose vehicles, or SPVs, are a popular way to raise funds for and invest in a single project. While their complexity depends on the target project, for the most part, they’re simpler than traditional VC funds (which deal with an entire portfolio of investments) and therefore more cost-effective from a legal standpoint.
Logistically, they can be set up as both limited liability companies and limited partnerships, though the former is by far more common than the latter. Because there are no set rules on how limited liability companies must be managed, SPVs can be set up in any number of ways. This means that the legal documents can be as short as fund managers want them to be, or vice versa. If fund managers are interested in fundraising for and investing in only one project, then SPVs are the way to go, as they can be exceedingly fast and simple to structure.
Multi-Layer Funds
Multi-layer funds are the antithesis to SPVs in complexity. In a traditional VC fund, there is the limited partnership, a GP entity, a management company, and possibly a carry entity for distributions. In a multi-layer fund, the GP entity, the management company, and the carry entity can be stretched in all directions, even across borders.
For example, each of the aforementioned entities could be split into smaller entities, each of which may or may not have a relationship with the others, but which would still have a relationship with the limited partnership. The smaller entities could be set up in different countries, or stacked on top of one another, with profits and expenses flowing back and forth between the layers. SPVs could also spin off from the limited partnership, with the GP entity, management company, and carry entity involved in some way with them.
What is the purpose of this complexity? Well, there are typically two ways that funds make money: first, from profits made from portfolio companies, and second, from the operational models of the funds themselves. Funds can be set up like a machine, in which the cogs (or entities) of the fund move against each other to generate distributions to investors. Creative investors can try to picture how this could work. In any case, when funds make money from their operational models, then a 2/20 distribution structure would definitely not apply, and alternative legal documents would have to be drafted.
Reimagined VC Fund
Even if fund managers decide to mostly follow the traditional VC fund model, they can still tweak things here and there. For example, they can decide to do away with the 2/20 distribution structure or any of the entities that constitute the fund (except, of course, the GP entity). Instead of setting up a limited partnership, they could even decide to form a corporation instead, with shares and a board of directors. Instead of investors joining as limited partners, they could join as shareholders and help manage the fund as officers or directors.
In a Nutshell
Funds can be structured in an unlimited number of ways. Before deciding on the traditional model, fund managers should brainstorm on the possibilities based on their investment thesis. Perhaps something simpler would work better, or perhaps something much more complex. Perhaps something entirely different from what I discussed above would work best. Given the rapidly changing market, fund managers should strive to be as flexible as possible in determining their profit and distribution logistics.
