Standardizing venture capital
How the lack of generally agreed upon standards in venture capital is used to exclude new entrants
Chris Harvey, my go to on all things venture law, once said: "Those practicing #law in #VC know there's no standard set of universal terms or documents.”
Or put more simply: “in VC […] there’s no standard.”
VC is the wild, wild west. It’s not just a risky, unpredictable asset class with an extremely high failure rate. Much of that wildness stems from the fact that there is no generally agreed upon rule book. Regulations abound, but the laws and statutes put in place by the SEC, IRS, and others are often vague (some would argue purposefully so) and left up to interpretation. There is also so much that falls outside of the domain of regulation – who is allowed to participate, how they are expected to behave, who has the upper hand – that results in a lack of industry-wide, agreed-upon standards. And even where there is regulatory clarity, enforcement is often spotty. Every investor is left to carve their own path, to answer their own questions.
Many take to the internet for answers: they scan Twitter, read blog posts, and search on Google. They ask questions like:
Do I have to set up an LLC?
Should I hire a lawyer? How do I afford one?
What is a registered investment advisor – and I am one?
What fees should I charge my LPs?
The internet can be a tremendous resource to answer these questions. There’s been a concerted effort by some industry veterans to share previously gate-kept information about how venture works behind the scenes. Venture is getting demystified — and some would argue, democratized.
But sourcing information from the internet isn’t foolproof. Didn’t your mother teach you not to believe everything you read? The ambiguity around venture law and regulation means that even those with good intentions can mislead or misinformation their audiences.
Automation requires some level of standardization. This is a recurring theme in many of our past articles — you can’t “Personalize the Pass” without a standard, consistent process for managing inbound deal flow. You can’t automate capital calls, investor relations, or portfolio company onboarding if each time you approach those activities, you take a completely different path. Automation - and the opportunity to use automation to drive efficiency and increase access - requires templates. It requires standardization.
As I’ve previously discussed, there is a single document - the LPA - which has been used in venture since it’s inception. Since the LPA governs “the money behind the money” (LPs), many of venture’s foundational characteristics can be linked back to it – two and twenty, the GP commit, waterfalls, quarterly reporting and audits, vice clauses, etc. It’s a powerful force. Yet, despite this document being used across 99% of venture capital for over five decades, there is no standard LPA. Every single new VC has to employ counsel (often at thousands of dollars an hour) to draft a new LPA before they even begin the fundraising process. This is one of many upfront costs that makes it implausible for those not from generational wealth to break into venture.
So let’s assume you do have a few grand to pay fund formation counsel. In theory, you, new fund manager, have the power to set the terms of your relationships with your LPs. You can include the GP commit or not. You can set premium carry after a 2 or 3x return to your LPs. You can remove the vice clause and invest in whatever the hell you want! And then… you can send the LPA to your LPs, who will spend hours with their own thousands-of-dollars-an-hour counsel to red line the shit out of it. And they’ll send it back to you, at which point you’ll have to decide whether you fork over another few grand for your lawyer to review their edits. Or, you just accept them. Because you need their money for your fund.
It’s in these exclusive (and often exclusionary), closed-door conversations that decisions are made about who should be allowed into the industry and how they should be expected to transact. It’s in these rooms where things like 2/20 are decided, expectations around GP commits are surfaced, and where pattern matching and warm introductions are reinforced. Even as those doors have opened ever so slightly to new entrants, you can see how a disproportionate amount of power is held by those who can continue to pay expensive lawyers to literally write their best interests into contracts.
But what if there was a standard LPA? What if there was a template you could download from a website, with a couple variable fields to fill out (a la the Y Combinator SAFE) and then go on your merry way – without the need to pay thousands of dollars to lawyers? What if we open-sourced the standard, so that the old white men behind closed doors didn’t get to dictate the rules of play and write them into law? What if we excluded things like the GP commit and unreasonable reporting requirements, but included opportunities for variable carry, customized waterfalls, and easier liquidity? What if we built a product that did all of that?
Automation still isn’t a silver bullet that will fix venture capital. But there is an opportunity to use standardization and automation to increase access to folks who don’t have their own personal team of lawyers and accountants or millions of dollars in the bank.
Oh yeah, and I’ve been working on that opportunity.