UK Law and Practice Contributed by: Dylan Doran Kennett, Michael Jacobs, Stephen Newby and Mark Ife, Herbert Smith Freehills LLP
Most VC funds are established as private fund limited partnerships (PFLPs), which benefit from a lower administrative burden compared to other limited partnerships. A VC fund structure may also include alternative investment vehicles or parallel funds to accommodate investors with specific tax or other structuring or investment requirements. Some VC funds in the UK take the form of pub - licly traded vehicles known as venture capital trusts (VCTs), which must meet a number of qualifying conditions. VCT investors (including retail) benefit from certain reliefs from UK taxa - tion. As a result, VCTs are mainly marketed to UK investors. 2.2 Fund Economics The principal return to VC fund principals is a share of the fund’s profits, referred to as “car- ried interest” or “carry” , which ensures economic alignment between the manager and investors. Carry structures vary depending on the respec - tive bargaining positions of the manager and investors. Under the typical distribution water - fall, a manager might expect to take 20% of profits above an ~8 “hurdle” , also referred to as the “preferred return” , meaning that investors must see a return of invested capital plus 8% before the manager takes a share. In principle, the waterfall operates in the same way for VC funds as for private equity buyout funds. How - ever, in a VC context, the hurdle may not be an internal rate of return or compound interest cal - culation. Rather, carry entitlement can often be contingent on achieving a multiple on invested capital (MOIC). Carry is typically calculated on “whole-of-fund” rather than deal-by-deal basis. This structure often includes “catch-up” , whereby, once the
preferred return is met, the manager receives a larger share of profits until they have caught up to a pre-agreed percentage of total profits. Less commonly, it includes “super carry” arrange - ments, whereby the manager takes a larger slice of profits if the fund meets a specified return. Although 20% carry (above the applicable hur - dle) is still the baseline for VC funds, it is more common for fund principals to take super carry on a VC fund than for private equity buyout strat - egies. The manager also receives a management fee (usually 1.5–2% pa of capital commitments) to cover its overheads. While management fees have generally been trending down over recent years, it is still common to see a 2% fee on a VC fund, which may be a reflection of smaller fund sizes in a VC context than for a typical private equity buyout fund. Other key market standard terms in VC funds include: • a provision to remove the manager for certain “cause” events (in which case the manager may forfeit some of its carry entitlement) and, in some cases, on notice without cause; • the establishment of an investor advisory committee with oversight over manager con - flicts of interest and other matters that could harm the investors’ investment; and • key person provisions under which the depar - ture or insufficient availability of certain key manager personnel triggers consequences such as suspension of the investment period or, occasionally, termination of the fund, unless investors approve its continuation. 2.3 Fund Regulation VC funds are classified as alternative invest - ment funds, or AIFs, and are therefore subject
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