It’s hard enough to get a job at a venture capital or private equity firm; it’s even more difficult to join as a partner. I recently went through the process myself in joining HOF Capital, and I thought it would be helpful to share some of my process.
If you join a fund, you’ll invest your financial capital but also — and more importantly — your reputational capital. So start by sharing an institutional LP due diligence checklist with the fund and asking them to share their data with you. Also see Preqin’s Key Due Diligence Considerations for Private Equity Investors.
VC and private equity are very illiquid on both the investing and the personnel side. So assessing fit is critical. Sean Seton-Rogers, a partner at Profounders Capital, breaks the conversation into three areas:
- Control: voting/veto for new deals, share of management company
- Compensation: base salary, share of profits of management company, carry
- Contact: to existing portfolio, to internal team resources, to LPs
Let’s take a look at each of these.
You’re going to make daily decisions with your colleagues on the investments you will jointly make. For some examples of public transparency on what investors are looking for, see HOF Capital, KEC (Brian Laung Aoaeh), IA (Roger Ehrenberg); and Georgian Partners.
Here’s an example of the kinds of disagreements you’ll face in a VC firm: Partner X invested in a company, which is now performing below expectations. X wants to invest more money because she’s on the board, has a closer relationship with the CEO, and failure will reflect poorly on her personally. The other partners have lost faith and want to cut their losses. What should the firm do?
To assess what level of control you’ll have, you’ll need to understand who is on the investment committee and how voting works. In any organization there will be disagreements. This is all the more true inside a VC firm, typically made up of former CEOs. So any well-managed firm will have an articulated mechanism for making decisions, taking into account input from all parties.
One proxy for understanding voting power is economics. In theory, carry correlates with decision-making power. In practice, the partner with a “hot hand” and recent wins is likely to have disproportionate influence; the same applies to the founding partner(s). According to the research paper How Do Venture Capitalists Make Decisions?, “Roughly half the funds [surveyed] — particularly smaller funds, healthcare funds and non-California funds — require a unanimous vote of the partners. An additional 27 percent of funds require consensus (20 percent) or unanimous vote less one (7 percent). Finally, 15 percent of the funds require a majority vote.”
Bloomberg Beta open-sources its entire operating manual on Github, where its website lives. The whole document is worth reading, but most relevant is this excerpt:
“We have an “anyone can say yes” policy. Yes, any of our team members can say yes. And no, you don’t have to meet my other partners. We believe the best founders and companies are polarizing. Our best investments might have been, originally, opposed by one or more of our partners. Teams are great at gathering information and surfacing wisdom, but terrible at making decisions. We believe in individual accountability — if anyone can say yes, then everyone feels the weight of making a decision. (That said, we do require that before anyone says yes they mention the investment to the rest of us — that way they get the benefit of the team’s input, and it’s a good way to slow down and think for a second.)”
At the opposite extreme, you have SoftTech VC. TechCrunch asked the firm’s founder, Jeff Clavier, “With three full partners, what will the voting structure be at SoftTech? Will your vote carry more weight than your new partners, or will two out of three votes get a deal done?” He said, “Everyone has to support a deal in order to get it done. There is always a champion with strong conviction advocating for the deal, and he or she leads the due diligence. If and when there is a skeptic, we’ll often have that person participate in the due diligence phase to make sure all questions or doubts are answered. There is obviously respect amongst us as a team, and if one of us really wants to do a deal where he or she has an established track record, others will defer and support – unless the “over my dead body” card is pulled, in which case we pass.”
Mike Margolis, an experienced VC and hedge fund investor, suggests you consider the following to determine your value to a firm: “Which of the partners at the firm share your skill set and how do you fit in? If you are one of six in the LP relationship area, you will have less leverage than if you are a new hire with the only European LP relationships. Are you bringing a track record that will facilitate marketing? In assessing your likelihood of success at the firm, think about how the firm has historically created value and how it intends to do so moving forward. What do you bring to this formula?”
As a negotiating point, you’re probably going to want to highlight that numerous top-tier VCs have equal carry in funds despite an often unequal ownership at the management level. Of course, many (probably most) high quality funds use a different model, with unequal carry and vesting based on seniority and other factors.
Among the VCs who publicly share they have an equal-carry model are:
- Aleph Partners (The Pioneer of the Equal Partnership)
- Atlas Venture (History doesn’t define future VC fund returns)
- Benchmark (https://www.saastr.com/which-vc-firms-have-equal-partner-economics-like-benchmark/)
- Charles River Ventures (http://www.crv.com/manifesto/)
- Foundry Group ( http://www.feld.com/wp/archives/…)
- Kepha Partners ( http://jtangovc.com/how-vcs-are-…)
- Madrona Venture Group (Dan Primack’s Term Sheet, June 6, 2012)
- Nextview Ventures ( http://robgo.org/2011/04/20/how-…)
- Union Square Ventures ( http://www.avc.com/a_vc/2011/03/…)
The Palico newsletter of April 12, 2016, included the citeable paragraph below on compensation:
“The founders of PE firms should be more generous. That’s the conclusion of a Harvard Business School study of 717 private equity partnerships by Josh Lerner and Victoria Ivashina that examines how “inequality” in the “allocation of fund economics” between founders and their partners negatively impacts their investors. While both the average founder and the average senior partner own 21 percent of their management firm, only the former takes home an equivalent portion of the firm’s carried interest the capital gains investors share with management companies. Senior partners take home a lower 15 percent of the carried interest. … Summarizing the study, Private Equity International notes that when compensation ‘bias’ is tilted towards founders, staff turnover rises significantly. This is ‘not in the interest’ of investors, ‘who want to build long-term relationships with stable, high-performing funds.’”
Note that this study is about private equity firms, which typically have much greater assets under management and pay their key people a much higher base compensation than a VC fund.
Contract (and other legal and structural issues)
You’re not rich enough to afford a cheap lawyer. It’s critical you get counsel to review your docs closely. Dolph Hellman, a fund formation lawyer, wrote a must-read article on issues to consider in creating a management company.
When I recently hired an attorney, I asked for referrals, and I got a very assertive advocate, Emily Campbell of The Campbell Firm PLLC. Emily’s advice, “When a new partner is to enter a pre-existing fund organization, there is usually a well-established dynamic among the existing partners that will necessarily experience readjustment. How this new partner will be treated in the group goes beyond just the economics. What initiatives the new partner will be able to take and what decisions the new partner will be able to make in the group context can be informed by subtleties in the documents regarding board positions, outside activities, access to investors, and interactions with LPs and the broader community. An effective lawyer will assist the client in thinking through more than just compensation and carry, and think about setting up the partner for success in the long-term relationship formalized when the new partner finally signs.”
Dror Futter, Partner, Rimon Law, points out, “If you are joining an existing partnership, step one is a review of the firm’s fund agreement. There can be significant variation among fund terms. These terms will define the economic pie management will divide and many of the obligations and limitations imposed on fund management. If this is your first time as a fund manager, consult with an experienced professional to identify non-market terms in the partnership agreement. The presence of non-market terms may reflect difficulties in fundraising or the idiosyncratic demands of one or more LP’s. The ‘back-story’ to these terms can give you valuable insight into the strength of the fund. The sad reality is that a not insignificant portion of funds fail to even return investor’s money and therefore do not raise a successor funds. Most fund “deaths” are not quick. Funds continue in a zombie-like state during which they make no new investments and have limited capacity for follow-on investments. During this period, most fund agreements provide for gradually diminishing management fees. It is therefore important to understand what the partnership agreement and your employment agreement with the fund state with respect to this fund twilight period. For example, in some fund agreements, partners are required to devote all or substantially all of their time to the fund. Understanding when and under what conditions these restrictions are lifted could help you avoid becoming ‘trapped’ in a zombie fund.”
David Sorin, Office Managing Partner, McCarter & English, said, “Assessing your value includes many elements, including experience, expertise, track record in identifying and consummating deals with high rates of return, and fundraising, among others. Of course, compensation is critical, but so is negotiating and documenting your management role (both authority and accountability), including delegated authority and voting power. With respect to voting power, consider your management role relative to the allocation of authority and voting power generally.”
Among the issues to consider in your negotiation:
- Overall group budget and budget for your specific areas of responsibility
- Protection against constructive termination
- Protection against dilution when adding partners
- Approval process for new partners
- Two-way nondisclosure and nondisparagement
- Expense policies
- Key man clause
- Economics in both the current and future funds
- Structure and timing of next fund
- The firm and your capital commitment
- Share and vesting of carry
- Tax distributions
- Guaranteed salary from management company
- Ownership share of management company
- Membership on investment committee (voting rights, etc.)
- Policy on outside activities and investments
- Policy on usurpation of business/investment opportunities
- Restrictive covenants (nonsolicitation and noncompete restrictions)
- Ability to be removed/terminated (cause, without cause) and consequences (effect on vesting, ownership in management company, effect on remaining capital commitment if any, and effect on noncompete)
- Employee and investor noncompete/nonsolicitation
- Policy on sharing track record
- Ownership of the brand (i.e., name of the fund)
- Reimbursement of legal expenses
- Ability to resign without cause (notice period and noncompete)
- Indemnification and D&O insurance
- Clawback scenarios.
Good luck in finding your dream opportunity!
Thanks to Emily Campbell of Campbell Firm PLLC, Dror Futter of Rimon Law, David Papier of Dentons, and David Sorin of McCarter & English for their contributions to the issues checklist above. I am not a lawyer and don’t claim to offer any legal advice. None of the lawyers mentioned are responsible for your understanding of their comments or your consequent actions. This is not to be taken as specific legal advice applicable to particular issues or circumstances.