Different investment themes have different risks in the investment market. This article will introduce common entities in traditional finance, such as partnerships and general partnerships, and then introduce DAO, a common entity in the crypto market. This article is based on the column article “A Brief Discussion on Risk Investment #2: Common Investment Entities” by DAOSquare, compiled, edited, and written by Foresight News.
Table of Contents
Partnerships
General Partnerships
Limited Partnerships
Limited Liability Company
SPV
DAO
Conclusion
Most jurisdictions around the world have legal entity requirements or recommendations for venture capital businesses. Therefore, most institutions engaged in venture capital businesses will establish a legal entity in the local jurisdiction. The following are several legal entities that frequently appear in the investment field. You can also visit the official website of the Small Business Administration (SBA) in the United States to learn more about types of business entities.
Partnerships are structures in which two or more people jointly own a business. There are three common types of partnerships: general partnerships (GP), limited partnerships (LP), and limited liability partnerships (LLP). Since limited liability partnerships (LLP) can only be established by certain types of professional service businesses, such as accountants, lawyers, architects, dentists, doctors, and other fields considered professionals under state laws, they are not commonly seen in the VC field. Therefore, we will only introduce general partnerships and limited partnerships.
General partnerships (GP) are structures in which two or more people share the management and personal liability of a business. This is the simplest structure that partners can choose when starting a business. Establishing a general partnership is simple. It only requires registering a name, obtaining an EIN number, and formulating and signing a partnership agreement. Due to the low operating costs and no need to file with the state, pay application fees, or franchise tax, GPs are used by tens of thousands of investment clubs.
In a general partnership, all partners are personally liable for the debts and obligations of the business. Each partner in a general partnership is responsible for the actions of other partners. General partnerships are the easiest to establish and have the lowest ongoing operating costs, but partners bear higher personal risks.
Limited partnerships (LP) are the most common legal entities in the venture capital field, and most funds use limited partnerships as their legal entities. We can quickly understand what a limited partnership is by looking at the roles and responsibilities of partners in venture capital operations.
Limited partners (LPs): These partners are investors who provide funds to the fund, so they are also called investors in the fund. Limited partners do not participate in the day-to-day management and operation of the fund. Their liability is limited to their investment amount in the fund, which means limited partners have limited liability. This means that once the fund faces compensation, bankruptcy, or litigation, limited partners are only responsible for the relevant liability within their investment proportion.
General partners (GPs): GPs are usually institutions or individuals who manage the fund. General partners are responsible for investment decisions, managing the investment portfolio company, and striving to create returns, so they are also called venture capitalists. Unlike limited partners, general partners have unlimited liability.
Usually, general partners and limited partners will sign a limited partnership agreement (LPA) as a legal document to specify the relationship and terms between the two, including management fees, profit distribution rights, fund duration, and other details. In addition, regulations in different jurisdictions may vary. If you plan to establish or join a fund that uses a limited partnership as a legal entity, it is recommended to consult the relevant departments in the local jurisdiction.
There are many reasons to form a limited liability company instead of a partnership, including liability and ownership roles. Most importantly, a limited liability company provides the benefits of both a corporation and a partnership structure to business owners. This makes limited liability companies an excellent business structure for medium-risk and high-risk enterprises, as owners with substantial personal assets can be protected.
Limited liability companies have the following characteristics:
Limited liability: Owners (or members) of limited liability companies are not personally liable for the actions of the company and other members.
Greater flexibility: Members of limited liability companies can be individuals, partnerships, trust companies, or corporations, and there is no limit on the number of members. Limited liability companies can also decide whether their members manage daily operations (member-managed) or whether these responsibilities are performed by non-members (manager-managed).
Increased credibility: Compared to general partnerships, limited liability companies can more effectively help new businesses establish reputation.
In the investment field, powerful investment clubs may adopt LLC as their legal entity to better protect the personal assets of each member. In addition, if an institution serves as the general partner in a fund executed by a limited partnership (LP), the general partner often adopts LLC as its legal entity. Using LLC as a legal entity not only provides flexibility in management but also to some extent protects the personal assets of fund managers from risks related to fund debts or litigation.
The disadvantage of establishing a limited liability partnership or limited liability company is that their establishment and operating costs are higher than those of partnerships. They require payment of organization fees and ongoing fees, and the need for a lawyer to draft the articles of organization, among other requirements.
A Special Purpose Vehicle (SPV) is usually an independent entity established by a parent company for a specific purpose, also known as a Special Purpose Entity (SPE). SPVs allow multiple investors to pool funds and invest in a company. SPV is a design of entity structure that can be established as a limited partnership (LP) or a limited liability company (LLC). It is important to note that SPVs are usually a concept relative to the parent company, which means that SPVs are often separate entities divested from the parent company.
SPVs are also commonly used in the venture capital field. SPVs can help funds or venture capital companies achieve more flexible investment operations. For example, when a specific investment project does not align with the investment philosophy of a fund or investment company, limited partners or company members can voluntarily choose whether to join the SPV. In addition, isolating specific startups within an SPV can protect the investment from risks associated with other investments held by the fund or venture capital company. For investment funds and investment companies, SPV is a very flexible and practical tool.
The biggest difference between SPV and traditional venture capital funds is that SPVs invest their entire capital in one company. Traditional venture capital funds or investment companies invest in multiple companies that meet the investment themes of the fund at different stages and industries. In addition, traditional venture capital funds or investment companies are long-term investments, and it may take up to 10 years to exit each investment in the portfolio. In contrast, SPVs usually seek to return funds to investors in a shorter time frame, as the realization of returns depends solely on the exit of one company, such as through acquisition or IPO.
DAO, which stands for Decentralized Autonomous Organization, can be understood as an organizational type based on code execution.
In recent years, with the rise of blockchain technology and the concept of crypto, many funds have started to use DAO tools to establish and execute on-chain funds. Compared to traditional fund execution models, DAO has shown its advantages in many aspects, such as:
Funds are held in smart contracts, which provides more security for investors’ funds and expands the credible boundary of fund financing.
Partnership agreements and fund rules based on smart contracts enable better protection of investors’ interests and reduce the operating and management costs of the fund.
Clearly, the advantages of DAO go beyond these, but they are not discussed here. We will write a separate article to introduce it.
The legal status of DAO may vary depending on the jurisdiction in which it operates. Currently, some jurisdictions may recognize DAO as a legal entity, while others may not have specific regulations or laws for DAO. Therefore, if you plan to establish or participate in a fund executed through DAO, it is recommended to consult the relevant departments in the local jurisdiction.
However, one trend we see is that more and more countries and regions are trying to embrace this emerging phenomenon, such as Ohio in the United States, Switzerland, Singapore, Estonia, Malta, the Marshall Islands, and more. With more legal jurisdictions supporting crypto, DAO is likely to become a technology-driven emerging entity category.
General Partnership (GP): A structure in which two or more people share the management and personal liability of a business. The simplest structure that partners can choose when starting a business. Due to its simplicity and low cost, it is adopted by most investment clubs in the United States.
Limited Partnership (LP): Composed of general partners and limited partners. The most common legal entity in the venture capital field, and most funds use limited partnerships as their legal entities.
Limited Liability Company (LLC): Owners (or members) of LLC are not personally liable for the actions of the company and other members. Powerful investment clubs may adopt LLC as their legal entity. General partners in a limited partnership (LP) often adopt LLC as their legal entity.
SPV: Allows multiple investors to pool funds and invest in a company. It can be established as a limited partnership (LP) or a limited liability company (LLC). The biggest difference between SPV and traditional venture capital funds is that SPV invests its entire capital in one company, with a shorter exit time.
DAO: DAO is an organizational type based on code execution. Compared to traditional entities, DAO has many advantages and is likely to become a technology-driven emerging entity category.
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