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When a venture fund reaches its end-of-life but still holds active assets, the fund manager must liquidate the positions in order to compliantly wind-up the fund.
Liquidating a venture fund is a complex process that, without careful planning and execution, creates a high risk of impacting Limited Partner (LP) relationships and even leading to litigation.
This article discusses the key goals and risks that venture fund managers should consider during a fund liquidation process.
Venture funds are typically structured with the assumption that the fund manager will invest a majority of capital in the first two to three years, deploy any remaining capital within four to five years, and return capital to investors within ten years. The Limited Partnership Agreement (LPA) defines the period in which LPs can expect their capital to be returned (often referred to as the venture fund’s “term” or more colloquially as life or lifespan). While the duration can differ across funds, a common fund life is ten to twelve years with an option to extend one to two years at the fund manager’s discretion.
After an investment is made, a venture fund typically holds the position until the underlying portfolio company shuts down, gets acquired, or goes public.
With some investments, the portfolio company continues to operate without a liquidity opportunity for the fund past the fund’s defined termination date. It is in this scenario that the fund manager is obligated to pursue a fund liquidation process.
For venture fund managers, the primary goals and requirements for a fund liquidation process are to:
Fund managers have both fiduciary duties and contractual obligations to LPs that define the baseline requirements for winding up a fund.
Chief amongst the fiduciary duties within the fund liquidation context is the fiduciary duty of care. A fund manager’s duty of care to LPs requires that they conduct reasonable diligence and exercise reasonable judgment when making decisions that impact their investors.
Fund managers can demonstrate their duty of care as the fund nears its termination date through:
Managers should also be vigilant of the duty of loyalty when it comes to any end-of-life activities in which they are transacting with the fund (for example, purchasing assets from the fund).
Activities impacted by these fiduciary duties are often best undertaken in collaboration with service providers who are experienced at winding up funds. These service provider fees can often be treated as a fund expense under the LPA.
A fund manager’s contractual obligations include liquidating and dissolving the fund when term extensions are exhausted and honoring side letter agreements and portfolio company agreements for transfers.
Most fund managers spend years building relationships with their LPs. Each stage of the fund, from pitch to final return of proceeds and dissolution, is an opportunity to strengthen the firm’s brand with investors.
Particularly as the fund approaches its end-of-life, LPs may be curious for updates regarding potential write-offs, asset sales, and distribution plans. Fund managers should proactively communicate with LPs and clearly outline next steps regarding any active fund positions.
A well-managed fund liquidation process can enhance the firm's credibility and foster future investment opportunities.
An efficient fund liquidation process focuses the fund manager’s time and attention on key decision points and systematically completes operational and process requirements - allowing the fund manager to dedicate energy towards strategic matters and other commitments.
A large volume of LPs in a fund and/or a high volume of active positions can complicate the liquidation process. More stakeholders and assets to manage leads to greater coordination costs – disposing of illiquid, private assets is typically a bespoke process.
The most acute risk for fund managers is selling an asset before it significantly increases in value. Selling assets before there is a portfolio company liquidity can lead to lost potential returns for LPs.
Due to information constraints in private markets, it’s difficult to eliminate the risk that comes with selling a fund asset before the portfolio company has had a liquidity event. However, it is possible to reduce the risk from an LP in case the asset substantially increases in value after the fund sells it by demonstrating that the fund manager exercised its duty of care.
Specific ways this risk can be reduced include through a) pursuing an in-kind distribution to LPs (transferring securities directly to LPs) when possible and b) undertaking a thorough sales process and documenting it carefully.
Onsen supports venture fund managers through the fund liquidation process. We guide the order of operations, handle investor questions and elections, and manage administrative filings.
Our team of experienced operators help SPVs and funds navigate write-offs, in-kind distributions, or sales processes via our network of secondary buyers and brokers.
If you’d like to learn more about our services, please send us an email at team@onsenfinancial.com.