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The future of VC is decentralized
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The future of VC is decentralized

Why it’s time to blow up the LPA

Halle Kaplan-Allen
Jul 2, 2021
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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.

Twitter avatar for @LDEakmanLD Eakman @LDEakman
TBC - I'm taking aim at the fund formation legal process and form of LPA. People are solving the sub doc interface, the back office accounting and communications, the sharing of docs for DD, etc.

LD Eakman @LDEakman

If anybody wants to disrupt fund formation with software (a la turbotax), they should call me. I hate this process and the documents are a joke.

December 16th 2020

1 Retweet30 Likes

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:

    Twitter avatar for @hotgirlintechlex 🍑 @hotgirlintech
    there's a reason founders want to stack their tables with operators

    Dan @DanHightowerJr

    Before becoming a founder, I worked at a VC. We dunked on startups after pitches behind closed doors: "their model doesn't work" "their competition'll beat them" "its just a feature" Now that I'm a founder, my first thoughts are "Damn. What you're doing is hard! Keep going!"

    June 11th 2021

    4 Retweets57 Likes
  2. Founders want more control over their fundraising processes. Products like AngelList’s RUV show a future in which GPs are less relevant:

    Twitter avatar for @sriramkri✨ Sriram Krishnan ✨ @sriramkri
    Most common feedback from founders about Roll Up Vehicle (RUV) from @AngelList: "The best 8K I've spent" "I'm ashamed I didn't use this in earlier rounds" "Wish I had it at seed" "Wish it existed earlier" "Why wasn't this available b4?" This is what 100 NPS score looks like.

    April 27th 2021

    6 Retweets113 Likes
  3. Operators who have gotten rich in the tech industry want to spend their earnings supporting future founders:

    Twitter avatar for @smartyMarty Ringlein @smarty
    Excited to announce we’ve officially closed on the Meta Fund I — a fund exclusively comprised of LPs who are founders and seasoned operators investing in early-stage start-ups!
    Meta Fund | Investors in Founder-Market-FitA collective of successful entrepreneurs and seasoned operators that co-invest in early-stage startups.meta.fund

    June 21st 2021

    7 Retweets105 Likes
  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:

    Twitter avatar for @b_nicks11Brian Nichols @b_nicks11
    1/ I’ve become the go-to guy for anyone starting a “tech mafia syndicate” -- and I’m not mad about it. Tech mafia syndicates are groups pulled together by current/former employees that invest together in startups where we think we can add value (all of us use @AngelList).

    February 13th 2020

    34 Retweets379 Likes
  5. VCs are using parallel fund models to hack the limitations of traditional venture fund mechanics:

    Twitter avatar for @rrhooverRyan Hoover @rrhoover
    We just closed Weekend Fund 3. 😊 Our latest early-stage fund is backed by 350+ operators and founders, a foundation for our upcoming community projects. Here’s how and why we raised from so many (exceptional) LPs.
    weekend.fund/1-000-true-lps1,000 True LPsweekend.fund

    June 24th 2021

    58 Retweets1,151 Likes
  6. GPs are giving portfolio founders priority access as LPs:

    Twitter avatar for @shlSahil @shl
    More early-stage founders should invest. Most don't have the time. One solution:
    shl.vc founders now get priority access to become LPs in the fund, with the lowest possible minimum, no management fees, and reduced carry.Sahil LavingiaInvesting $10 million a year into early-stage technology startups.shl.vc

    June 22nd 2021

    21 Retweets277 Likes
  7. Scout programs and venture partners have become increasingly popular:

    Twitter avatar for @paigefinnnpaige finn doherty @paigefinnn
    hey aspiring vcs 👋 we're going to explore venture capital scout programs: what they are, why they exist, and how to pick and join one...[a thread]

    October 28th 2020

    60 Retweets574 Likes
  8. The emerging interest in using a DAO as a syndicate highlights the appetite for shared decision-making:

    Twitter avatar for @JuliaLiptonJulia Lipton @JuliaLipton
    1/ Internet, please help brainstorm! How do I design an Awesome People DAO 🥳 ? Goal: design a system where smart nice people win in VC. It might not be possible, but I'm damn sure going to try. Context, use cases, and questions 👇

    June 5th 2021

    10 Retweets166 Likes

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.

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Camila
Jul 20, 2021

Whats your take on equity crowdfunding?

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8BIT
Jul 5, 2021

the future? it's always been this way. you literally describe a decentralized model... LPs give GPs money and that gets distributed to founders and the founders usually have no idea who the LPs are...

... right?

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