Today’s Topic: why you’ll have to shut down your venture fund and options to do it (hint, we all have to) 

Raising a first-time fund is a massive accomplishment.

You deserve high-fives all the way around. A round on the house. Hooray! And now you get to start writing checks.

But did you know that one day you’ll have to shut down the same fund that you just raised? This doesn’t mean it wasn’t successful. Even the most successful venture fund managers have to one day close up shop, turn in the key, and move on to their next chapter. 

What exactly does this mean? And why can’t your mega-amazing fund live on forever?!

Let’s explain

When you raise capital from LPs to invest in companies, your job is to pitch the LPs on your investment thesis (essentially, what kinds of companies you’ll be investing in and why it’s a good idea). If the LP likes what they’re hearing, they may invest. 

But that’s only half the story. One day, they’re going to want that money back (or at least, whatever is left of it) so they can spend it, re-invest it, or send their kids to college. 

And since investing in the private markets is highly illiquid, LPs want to make sure that there are assurances in place so their money isn’t in limbo forever. 

There are two primary ways a fund returns proceeds to LPs:

1. The portfolio company has a liquidity event (e.g., the company goes public or gets acquired; there is an opportunity for the fund to sell its shares to another buyer).
2. The portfolio company shuts down. 

For many investments, one of the two above scenarios occurs within several years. However, sometimes a decade or more passes without either happening – and LPs grow impatient.

Enter 👉 a fund’s lifespan. 

Its purpose? To predefine when a fund must cease operations and return any proceeds to LPs. 

Sound complicated? We’ll explain it below 👇

But before we do that, there are a few phrases in this article that can be confusing, so we’ll define them first:

• “Fund lifespan” ➡️  A predefined period of time that your fund exists as a legal entity (typically 10 years with the option to extend by 1 or 2 years).  
• “Shut down your fund” ➡️  End your fund’s legal existence.
• “Liquidate your fund” ➡️  Sell or transfer your fund’s assets.

So, what are your responsibilities as a fund manager?

Your fundamental responsibility to LPs as a fund manager is to maximize the return on their investments (if you’re an LP reading this, you can exhale now). Ideally, you do so in a way that builds trust and enables you to raise future funds if you would like. 

Most venture fund lifespans are 10 years with 1-2 years available for extension. Once the fund’s lifespan and extension period lapse, the fund needs to shut down.

To understand more about this process, I interviewed Anne Seckinger, Managing Director of Onsen. Onsen is an advisory firm for early-stage startups and venture funds. 

As Anne explains: fund managers have 3 main goals and requirements when shutting down a fund:

1. maintain LP goodwill and a positive firm brand
2. meet fiduciary and contractual obligations
3. manage an efficient liquidation process. 

Let’s dive in.

1. Maintain LP goodwill and firm brand

LPs invest in venture funds with the expectation that, within about 10 years, they will get their money or whatever remains of it back. They also expect that the fund manager will give reasonable effort to maximize the investment. 

If you haphazardly sell remaining assets for pennies on the dollar, your LPs will likely be upset. 

You may have “successfully” liquidated the fund and be ready to shut it down, but at the expense of your LP relationships… not the goal! 

2. Meet fiduciary and contractual obligations 

As a fund manager, you have fiduciary duties and contractual obligations to your LPs and portfolio companies. You can think of this as a code of conduct. 

Your job is to act in the best interest of your company and its beneficiaries – in this case, the fund and the LPs. 

When shutting down a fund, this means trying your best to obtain the highest return possible for LPs. You also have contractual obligations to honor side letters and share transfer agreements with portfolio companies. 

When you shut down your fund, you need to keep these obligations in mind.  

3. Manage an efficient liquidation process

An efficient liquidation process is well-documented, orderly, and doesn’t take a huge amount of your or your team’s time. 

You’ll need to pursue a liquidation and shutdown strategy that fits the goals and limitations of your fund, LPs, and portfolio companies. More on this next. 

Options for shutting down 

If your fund is no longer invested in portfolio companies (e.g., all of your portfolio companies have either exited or dissolved), then the process to shut down your fund is pretty straightforward – mostly it’s administrative work. 

Things get interesting when your fund reaches the end of its life and still has assets. In this situation, there are two options to liquidate the assets before shutting down:

Option 1: Sell the portfolio company shares and distribute cash to LPs

The benefit of option 1 is that LPs will see some cash returned to them as the sales close. 

The downside is the possibility of tail risk. What is tail risk? Tail risk refers to the possibility that you sell the shares, then the value of the shares increases, and your LPs miss out. 

Option 2: Transfer the portfolio company shares pro rata to LPs (called an “in-kind distribution”) 

In this scenario, the fund manager transfers the shares of the portfolio company that the fund holds to the LPs based on how much of the fund each LP owns.

This option reduces tail risk to the fund manager because the LPs are able to let those investments continue to mature. 

However, some companies don’t want to deal with the burden of coordinating the transfer of shares from a VC fund to all these different LPs. 

The verdict? Companies are much more likely to approve a sale of the shares on the secondary market. This strategy also makes it easier for the fund manager to calculate carry (how much the fund manager earns on the investment).

The takeaways

Being a fund manager isn’t just about raising capital from your investors. It’s also important to think about your fund’s future and the options you have for shutting down your fund while doing right by your LPs. 

Understanding your fund’s lifespan should better prepare you for conversations with potential LPs, and help you decide whether you should invest in a company (can you see an exit opportunity within the next decade?).  

Ultimately, by shutting down your fund the right way, you should be able to maintain good relationships with your LPs and meet your obligations as a fund manager.

This article was written by Tucker McKay. Tucker is the founder of Ikaria Labs, a content marketing agency for funds, fintechs and financial services companies.