A venture capital partnership agreement is an agreement between the general partners and limited partners in a venture capital fund.

Partner Roles

In a venture capital fund, general partners perform several roles at the same time, such as the following:

  • Manage the investments of funds
  • Pursue investment opportunities

Limited partners invest capital with an expectation that general partners have the ability to identify the right kinds of investment opportunities. Limited partners expect an attractive return for their investment.

General partners may have significant business experience as well as management expertise. In many cases, their principals or employees act as a company's directors or officers.

General partners may also act as financial intermediaries for the following purposes:

  • Assisting a portfolio company in obtaining necessary debt financing
  • Structuring the investment of a venture capital fund in portfolio companies
  • Identifying other funds for financing rounds

About Venture Capital Funds

Typically, a venture capital fund is organized as a limited partnership. Limited partners provide investment capital, and general partners provide their asset management services and investment expertise. In exchange, general partners usually expect significant profit participation as well as some type of management fee.

In this limited partnership, general partners could be individuals. More often, they're limited liability companies or corporations.

Limited partners may be a diverse set of investors, including the following:

  • Pension funds
  • Insurance companies
  • Investment banks
  • Charitable foundations
  • Wealthy individuals

Limited partners are typically sophisticated, wealthy investors who want to work with a venture capital fund's general partners. They want the general partners to identify good investment opportunities and make appropriate investment decisions for them.

Limited partners may lack expertise in a certain industry or be unable to make direct investments in privately held businesses. Therefore, they depend on general partners to choose the right investment opportunities.

Partner Duties and Responsibilities

Because general partners are managers of venture capital funds, they have certain legal obligations to limited partners. These obligations are based on statutes or contractual provisions and are outlined in a limited partnership agreement. The general partners' obligations determine the relationship between them and the limited partners, as well as any ensuing liabilities.

Many of a general partner's obligations are specified by statute. They're unable to amend them via contractual provisions.

Some of the obligations may include the following:

  • Loyalty
  • Good faith
  • Care
  • Fair dealing

The duty of loyalty especially applies to general partners. This includes the obligation to refrain from competing with the venture capital fund and from adverse dealing. Limited partners may call a general partner's compliance into question if they feel the general partner is managing more than one fund at the same time.

In a technical sense, general partners act as agents for limited partners. The limited partners pay management fees and have a vested interest in the general partners' expertise.

Specifying Duties in an Agreement

When a venture capital fund is formed, it's important to specify the duties of the general partners at that time.

The limited partnership agreement should provide for the following:

  • Capital distributions and gains
  • Any negative events that could happen during the life of the fund
  • Any restrictions on a general partner's powers

All of the partners in the venture capital fund should carefully consider all of the possibilities when drafting the agreement.

A key provision in the agreement is how much authority to give general partners regarding investment decisions. Limited partners might decide to trust the general partner, with a willingness to accept the partner's decisions for the limited partnership. On the other hand, limited partners might decide to limit the general partner's authority regarding investments.

It's important to specify all provisions relating to the scope of authority the general partners have, including any restrictions on their powers. These provisions can act as an important defense in case the limited partners get impatient regarding a lack of return on their investments.

Investors tend to expect some type of return. If they don't have the necessary expertise in a particular field but still want to enjoy the advantages of investing in it, partnering with someone who does have that expertise and knowledge can be beneficial. A solid partnership agreement that fairly compensates both sides is one way to have a relationship that benefits everyone.

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