The venture capital marketplace is poised to change in fundamental ways over the next few years. At one level, these changes will result in fewer firms raising capital and a return to business methods that existed when the "private equity asset class" was not an asset class at all. At an even more fundamental level, the relationship between general partners and limited partners will adjust to the new economic and industry realities.
Does that mean that the much anticipated shift in power to the limited partners will occur, or will there be a realignment of interests between general partners and limited partners that embraces the ways of old but recognizes the needs of increasingly sophisticated institutional investors? The answer to that question may differ depending on a venture capital firm’s standing in the industry.
Two areas where these differences are likely to manifest themselves are with respect to partnership terms and conditions and the avoidance of public disclosure of private equity data.
Terms and Conditions. The negative performance results of the past few years in the venture capital industry are expected to cause a "flight to quality" as many firms that last raised capital toward the end of the bubble years launch new fund offerings in the next year or so. More than ever, limited partners will be looking for firms that have been successful over a long period of time. As a result, competition among limited partners to invest in funds sponsored by firms with superior long-term track records will be intense.
This competition will likely be exacerbated by the expected decline in the size of new funds sponsored by top-tier venture capital firms. The most recent funds formed by these groups were often of the "mega-fund" variety. Smaller funds means there will be little or no room for new investors in these funds, and existing investors may not be able to invest as much as they would like. Because of the demand for top-tier venture capital firms, these firms likely will not have to make significant changes in their key terms and conditions in order to raise capital for their next fund. For these groups, any adjustments in the relationship between the general partner and the limited partners will be more subtle.
On the other hand, there is more likely to be a shift in power to limited partners when it comes to newer firms and firms without superior long-term track records. These groups may need to make significant concessions in their economic and governance terms and conditions in order to attract investors for their next fund.
Public Disclosure. Many venture capitalists are very concerned about the increased disclosure of fund performance information by their public entity limited partners, particularly as it relates to portfolio company data. One way in which fund managers can avoid disclosure is to avoid having a fund’s information become a "public record," either by not permitting public entities to invest or by establishing reporting provisions that limit the type of information provided to public entity investors or the way in which it is provided to them. The funds that are more likely to be in a position to avoid disclosure in this fashion are those that have the ability to be more selective in their choice of limited partners and to negotiate more favorable terms and conditions (i.e., the top-tier firms).
So while public disclosure of fund performance data will be a fact of life for most venture capital firms, a small but important segment of the industry may be able to avoid disclosure of this information.
Will top-tier venture capital firms avoid the impact of general trends in partnership terms and conditions and the disclosure of performance results? That question, and the question of who is a top-tier venture capital firm, will be answered over the next couple of years. However, it appears that top-tier firms may be in a position to live by a set of rules that have more in common with the venture capital industry of old than its immediate future.
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.