The future of VC is decentralized

Why it’s time to blow up the LPA

VC is a relationship business -- as we’ve previously discussed, this is why industry folks tend to be so resistant to process and tooling. And yet we shouldn’t forget that the relationships in VC are governed by numbers. The relationship between a VC and a founder is governed by the cash and equity. And the relationship between a fund manager and their LPs is governed by the terms in the Limited Partnership Agreement (LPA): management fees, carry, minimum investment, GP commit, and investment period.

When I was doing user research for the Emerging Manager Toolbox last year, a few patterns arose: a desire for tools that increase transparency, facilitate collaboration, and cut down on manual data entry. And also, a universal distaste for the LPA.

The LPA has been used since the inception of venture capital in the 1970s, but its origins actually go back much further. The earliest form of the limited partnership, referred to as commenda, dates back to 10th century Italy. The actual legal agreement emerged in the early 1900s through the Uniform Limited Partnership Act. While the documents established in 1907 have been revised many times, we’re still working off the skeleton of a document that is well over 100 years old - and a structure that has been around for more than 10 centuries.

Of course, the limited partnership has stuck around because it largely makes a lot of sense for the private markets. Specifically in venture capital, it allows investors to take risky bets on innovation in its earliest stages. But the venture capital ecosystem of today is a far cry from what it was a few decades - or even a few years ago. 

Over the past year, an abundance of capital has been funneled into private markets, which puts the leverage increasingly on the sides of those who are fundraising (be it founders or fund managers). But the current Limited Partnership structure and accompanying docs tell a different story. The industry is working off a decades-old document that places negotiating power in the hands of institutional LPs. The operational and financial burdens on fund managers represent major barriers to entry for emerging managers. It’s time to rethink the GP/LP structure, and the documents that govern it.

Today, many fund managers have the best of intentions when they start off using standardized documents. Inevitably, those intentions take a backseat to LPs exercising their power. Redlining an LPA or creating side letters with LPs is not only time consuming and stressful (see: MFN), but can cost a fund manager anywhere from $1,000+ in lawyer fees. Accommodating the nuances of modern investor relationships shouldn’t be gatekept by lawyers, and shouldn’t only be available to those who can afford to spend $60-120k on fund docs. Raising a venture fund is already hard enough.

Venture capital is at an inflection point. Both founders and VCs want to do things differently:

  1. Particularly at the earliest stages, founders want a diverse and engaged collective of operators on their cap table, not a single fund manager or syndicate lead who might limit founder access to their LPs:

  2. Founders want more control over their fundraising processes. Products like AngelList’s RUV show a future in which GPs are less relevant:

  3. Operators who have gotten rich in the tech industry want to spend their earnings supporting future founders:

  4. There are a growing number of syndicates run by teams of co-investors rather than a single fund manager, such as the alumni syndicates run by former Lyft, Affirm, and Google employees:

  5. VCs are using parallel fund models to hack the limitations of traditional venture fund mechanics:

  6. GPs are giving portfolio founders priority access as LPs:

  7. Scout programs and venture partners have become increasingly popular:

  8. The emerging interest in using a DAO as a syndicate highlights the appetite for shared decision-making:

Each of these examples shows a movement away from the relationship prescribed by the LPA. Technology - from AngelList syndicates to new insurgents to no-code solutions - has made it easier than ever to accommodate new types of investor relationships. Now the legal docs just need to catch up 

I don’t quite know what the solution is yet, but I feel pretty confident that we shouldn’t keep working off the same document that’s been used since the birth of venture capital. Emerging startups and the adoption of automation by the legal industry should make it easier to generate new agreements that accommodate the nuance of modern investor relationships.

And while I still don’t think a DAO should be used as a venture fund, maybe they were on to something with those smart contracts.