This is the eighth in our series of ten frequently asked questions from investors in venture capital partnerships.

Susan Mangiero, CEO of Investment Governance’s Fiduciary X, asked me the following:

Question: What happens if an LP wants to exit a VC fund? What are their rights?

Answer: The options here are limited, and they are (1) the LP can try to sell their interest, including the obligation to fund future capital calls, to a fund that acquires secondary interests.  The good news is that a robust market exists for such interests in venture capital partnerships today; or (2) default.  If you do wish to sell, the GP needs to approve the transfer, and the standard partnership agreement language leaves this decision in the “sole discretion” of the GP.  There is no free lunch if you change your mind several years into a 10-year-plus partnership participation. And there shouldn’t be, which also means that either the secondary market buyer will take their pound of flesh by buying the LP’s interest at a substantial discount, or the GP will by offering the interest and its economic value on a discounted basis to the other LP’s.  It is far less disruptive to the GP and to the GP-LP relationship for the exiting partner to sell to a secondary buyer, but these buyers are totally financially driven and are going to get the best deal possible for themselves.

Related posts:

1. VC Governance FAQ: (10) Are limited partner defaults on capital commitments triggering a wave of lawsuits in the venture industry?
2. VC Governance FAQ: (1) How much information are limited partners (pensions, endowments, foundations, etc.) entitled to receive from a VC fund?
3. VC Governance FAQ: (2) Especially now, when transparency is so important, why is limited financial information available from a private company?
4. VC Governance FAQ: (5) How are VC funds governed differently from the governance standards applied to their portfolio companies?
5. VC Governance FAQ: (6) Are contract terms in partnership agreements shifting in favor of institutional Limited Partners?

Tags: capital markets, regulation reform, securities regulation, Venture Capital, venture capital exits

This entry was posted on Wednesday, March 17th, 2010 at 8:00 am and is filed under Adult Education, Corporate Governance, Entrepreneur, Innovation, VC Board Best Practices, Venture Board Governance White Papers, Venture Capital, Web/Tech, Working Group on Director Accountability. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.