E454 | Karma Samdup & Vicki Odette, Haynes Boone: Fund Structuring, and Legal Challenges in Venture

0:00Vicky and Karma from Hainsboon reveal the hidden traps in fund formation that lock emerging managers into bad deals for years. That first big investor feels like striking gold. Oh my gosh, this investor is going to give me 50 million, 100 million. But excitement blinds you to the fine print. And these are the terms they want. Be very careful about how it's drafted because oftentimes the seed investors are going to want priority and better deals on your next fund. What you sign today doesn't just impact your current fund. Those terms can lock you into unfavorable deals for your second, third or even fourth fund.

0:37think through what are you giving up long term. And that's where lawyers can really come in. You know, helpful to say the way this language is drafted, they have rights to the second, the third, the fourth fund. Even seasoned investors who understand markets can find themselves completely outmatched when negotiating fund terms, leaving money and control on the table for years to come. Sometimes, you know, you know the investment world well, but you don't know how to negotiate, raise money, and what's fair or not fair. The wrong legal documents can torpedo your credibility and institutional investors before they even consider your strategy.

1:15Institutional investors are going to look at it and go, this looks like you got this off the internet. And the consequences, brutal. They're ugly. And so oftentimes a GP will say, wow, this is going to scare my investors off because they can forfeit their entire interest. We can sue them. How do you raise today without compromising your fund tomorrow? This episode could save you years of regret and millions in lost opportunities.

1:41Here's a few words from our beloved sponsor. This episode is presented with our good friends at Haynes Boom. At Haynes Boom, they understand the complexities and challenges faced by VCs. Specialising in fund formation, they expertly manage the establishment of multi-billion dollar funds and innovative private fund products, ensuring their VC clients are equipped to attract global investors and excel in competitive markets. Beyond fund formation, Haynes Boone is deeply involved in the life cycle of startups, providing nuanced guidance on everything from entity structuring and capital raising to navigating exits through IPOs and strategic acquisitions.

2:22Their comprehensive legal services support VCs in maximizing their investments and achieving successful outcomes. Whether you're looking to launch a new fund or invest in cutting-edge startups, Haynes Boone positions you at the forefront of the European venture ecosystem, enabling you to capitalise on opportunities across health tech, AI and beyond. Stay ahead of the curve by tuning in to the European VC Podcast. Join us in celebrating the art of venture capital with Haynes Boon.

2:56Tear down this wall. It's more than just an alliance. This is a union of values. Let's start acting, acting, acting. This show is not investment advice and the hosts of this episode may be invested in the funds and companies featured. Vicky and Karma, welcome to the European Easy Podcast. Thank you. And before we start, let me just thank you a million times for supporting us with the EUVC Summit Awards. You are sponsoring for the second year in a row, this time the Firm of the Year Award. And I just want to say thank you so much for that. We couldn't do these types of things that we're doing if it wasn't for our partners like you.

3:41So thank you. You're welcome. And that, of course, means that anyone listening in today, you should absolutely make sure to check out Hainspoon and think about Hainspoon when you're looking to set up your fund or think about the next fund iteration. Because this team is great. We got the introduction to Karma in the beginning. We actually met you at Isomer's AGM. That's right. So you can come highly recommended by Mr. Joe Schorch from Isomer. And I'm just super excited that we're continuing the partnership with you. A pleasure. Pleasure to be involved with you guys too. Now, Vicky and Carmen, first, let me get the context on Hainspoon.

4:22Let everyone understand what's Hainspoon all about. What do you do in the VC space? What do you do in other spaces? Just so they know. You know, I'm Vicky O'Dad. I'm the global chair of the investment management group here at Haynes and Boone. We're a full service firm all over the United States, London, Mexico, and Shanghai. And specifically what Carmen and I do is in the investment management space. So we work with sponsors to form venture capital funds, private equity funds, hedge funds, co-investments. We really span the alternative space, industry agnostic. I've been doing this for over 20 years, and we represent both the sponsor side and the limited partner side going into these types of investments.

5:09And I think it's helpful because we get to see both sides. We know what the limited partners want. We know what the sponsors want. And we can really help guide people to that happy medium where they can get a deal done. I think there's an important angle there, the DLP side as well, because I do think that many, especially emerging managers setting up their funds, have a lot more access to people that understand the GP side. Could you maybe expand a bit on where you see this being an important thing for your managers? Yeah, I mean, because when we work with limited partners going into these funds, we know what they're thinking.

5:50We know what their issues are, what they're going to ask. And we negotiate side letters with sponsors because we know what special provisions are market, what they can ask for, what sponsors are going to give, what they're not going to give. And so it's really helpful when we work with a sponsor, an emerging manager, we can tell them, hey, what you're going to go, this is what you're going to go through. This is what your partners are going to ask. Here's what's reasonable. Here's what's not. You know, and having doing both sides on a regular basis really does give us insight into what drives both sides of the transaction.

6:28And that's been super helpful. Plus, we see what other firms do. When we're representing a limited partner, we do deals all over the world. And so we see some of the best and worst venture funds from a lot of different places. And so we can help guide people and say, this fund needs a complete overhaul, or this is a really good investment. Can I throw you a curveball or a softball. You're going to definitely take it to a place where it becomes a softball. The curveball would be, say, how do you make yourself relevant as a boutique firm versus all of these platforms that we have? That's the curveball angle to it, the softball angle to it.

7:15So why is it so much more valuable to have an advisor on your side that knows what they're doing versus a platform where you can go in and click and get things set up quickly, but you don't have much direct expertise. So let me take that. So look, you know, Andreas, that I'm a man of tech. I love tech and the team that we have here in London office, especially we've got a roots in venture. It's not surprising to me that we've had a proliferation of these platforms that support young managers and I think particularly useful for micro-managers, micro-funds, to be able to launch quickly and efficiently to give themselves a chance to develop their track record.

8:01So I think there's definitely a space for this. I think the likes of Carter, Slash, Roban, Mara, et cetera, who I know you know Mara well as well. So I think there's a very important dynamic evolving at the moment, which I guess AngelList from the US were probably at the forefront of this going back a decade. or so. And I think when I launched my focus on the VC space in the private market space, and particularly in venture, I noticed that this was where people would not be happy with the status quo. And technology is always being used and leveraged to allow new opportunities to be scaled. And so I think it's unsurprising that the platforms have a part to play and are doing well in relation to that.

8:44I was at a boutique alternative assets focused law firm prior to joining Haynes Boone. Haynes Boone is, as Vick has just alluded to, a large AMLO 100 US and with London now, I guess, covering Europe as well. It's very focused on investment management as an entire sector. We're, I think, still relevant. I think all law firms who are specialists will remain relevant. And I think even more so with the birth of AI and the evolution of that as well. largely because, again, we need experts who are experienced on deal-making and deal-constructing, designing, et cetera, to be able to input into what is norm and what is, if you like, sometimes I think the value you bring is making deals happen most efficiently so that both parties, as I think, Vicky, you alluded to this as a happy medium, is helping people achieve their mutual goals in an efficient, sensible manner so that this is not a dispute, this is a transaction.

9:43Both parties want to get away. And the good lawyer, good advisor, I think supports that along that journey. Platforms, as I say, have a use. But nonetheless, it's still a platform developed by people who are probably not experts at the law and not experts at necessarily some of the other tools that might be required. So I think working in partnership with experts as a manager is probably the key. Leveraging the platforms when you need to is probably the key. I think not forgetting the resources you have available around you in terms of experienced service providers, and that can obviously span beyond law, remains, I think, very important and relevant.

10:21Beautiful. I wanted to touch on that directly and tag it head on because everyone knows that we work with both sides. And for that reason, I thought, let's get it out. Let's not leave it here lingering. I think you also all, and now I speak to the audience, you're going to also hear from this conversation the level of depth we can go into and the understanding and nuance and the perspective, especially this LP perspective where Vicky and Karma can really bring in some thinking that you can really, you know, is not something that you often come easily by. Karma, maybe touch on one extra thing. You chose to move your team to Haines Boone, what, two years ago-ish?

11:07Two years ago, yeah, roughly two years ago, correct. Time has flown by. Tell me, one line, why did you choose to do that? We looked at a number of law firms at the time. We moved our team across. We felt it was the best fit. We looked at UK, US law firms in the aggregate. We were excited as a team because there was clear signals being given to us by Vicky and Taylor, the managing partner, that Haines Boone was a sensible law firm that was collegiate, that was looking to the long term with a business plan that is always 10 years forward looking and sensibly run financially, etc. We've seen big law firms suddenly disappear, right?

11:48So we were slightly worried about that too. But most importantly, you know, there was an ambition to grow outside the US. And this was the time that this was about to happen. So we like that challenge, too. And then the final piece probably was that myself, Andrew and running the three partners in our group in particular, very much focused on non US law firms in the past week, we had referrals and so on when partners there. But it was a it was a time we felt where our clients as well, looking at the US always looking at the US, this would be a perfect place to come to be able to bring that, you know, direct support to the to the European-based clients looking to the US.

12:22One day we should do a deep dive episode on the intricacies of acquiring partner-driven businesses, acquiring and merging partner-driven businesses. I'm sure that's an interesting inquiry. It's very interesting and intricate. Yes. All right. So to everyone in the audience, as you heard me saying in the intro of this, Today, we're going to talk everything about how to make the fund launch easier. We have a tough environment, so we're going to talk about the legal issues you face, where it's important to focus, and where it's maybe okay to compromise. We're going to talk about GP, LP alignment, Cornerstone LP dynamics, the special provisions they ask for, how to navigate those.

13:06And then we close on how to compensate key employees of your fund. There's a lot of topics to cover, so let's get directly into it. if we start with the first one that I mentioned, making the launch of your fund easier. First of all, I just want to emphasize here, we're not talking about launching their first fund only. We're talking about launching the multiple fund iterations. And I say that because sometimes I meet managers that are like, well, we're going to be done with our legal stuff. So I don't need more counseling or I don't need, I don't want to, and I would say this because we're going to do bootcamp where I encountered some people that where their view was, well, I'm quite far in, so I don't think we're going to have front threes there as well.

13:51So I think there's enough time for you, Mr. First-time Fund Manager, to learn a bit. So there's a ton to get into here. If we maybe start from the top, what are the main legal issues that you as a Fund Manager should expect to meet when you're set out to launch your fund? From a legal point of view, right, I think the key question that invariably has to be tackled is a couple of the key questions. One is jurisdiction, where you're going to be launching your fund from. So the jurisdiction can encompass, for us, UK, Luxembourg is a very popular jurisdiction, as most of your listeners will know, for various reasons.

14:33Could be the Channel Islands and all the Cayman BVI and the US, of course, the Delaware region. So jurisdiction is key. Invariably, fund structures always have a transparent partnership in play. So those I would not expect to be questioning or reiterating in any way. And as a manager, I think, you know, if you're a first-time manager, especially understanding the dynamics of the structure, the tax implications and relevant as well as regulatory and marketing implications. So making sure you have that advice high level first. And as you go on your journey to fundraise, being very clear on all of that so that your discussions, your rapport with your LPs are extremely clear and don't raise red flags in the minds of the LPs around that.

15:16And that's something you can control. It's not about raising the money and LP writing you checks. And that's obviously the most difficult part is what I always tell clients. So I think jurisdiction, regulatory dynamics on marketing, et cetera, from a legal point of view, is very important. And then the last thing is probably just understanding fund terms, by which I mean your partnership agreement that you will invariably want to put in front of your LPs, understand your way through that and have a good advisor around you to talk you through them so you understand it and have a good network of other GPs, etc.

15:48who've been on that journey and understand it. So from a legal perspective, that is obviously key and that's usually where we would be spending a lot of our time helping our clients with. And Vicki, I don't know if there's anything else you got. No, no, I think it's very similar in the US. And I think just making sure that your terms are marked, you're not trying to do anything unusual, funky, as far as your legal terms go. Now, your strategy obviously can be as unique as you want. But, you know, investors want to see something that they're familiar with. You know, they know these are the market terms.

16:22And so that's, you know, something that's really important to make sure that your documents look fairly standard compared to market so that it makes it easier for investors to focus on your strategy and who you are as a manager versus these documents are really not in line with market because that's a distraction, you know, managers don't need. How much of this can be researched on the internet, asked to get GBT and cut and paste from friends? It's interesting because we have seen some managers come to us after they've launched and they had a successful initial fund and then they want to grow and they want to get bigger investors, family offices, institutions, but their documents are just not up to par.

17:11You know, institutional investors are going to look at it and go, this looks like you got this off the Internet. And sometimes they did or they got it off a platform. And that's, you know, fine for some micromanagers and et cetera. Some of the documents can be OK for that. But once you start growing and you become bigger, you need documents that are more substantive and address all the legal issues that investors are going to want and they're going to want to see in the document. And so I think that's pretty important that, you know, you start off with a strong set of good legal documents that not only protect you as the manager, but also give those key provisions that some of your investors are going to be looking for.

17:50For example, there may be certain investments that they can't make or they don't want to make. In industries, they don't. So they're going to need excuse provisions to get out of a certain investment if it's something that they just aren't aligned with, like ammunition or tobacco, alcohol, porn, whatever it is. So it's sort of a dual purpose. You want to make sure that the sponsor is protected, but you also want to make sure that you're making it attractive for the investors to come in. You're not creating obstacles for investment in your documents. Yeah, I think I probably had one small point, which is you can raise a fund, quote unquote, start deploying on very limited set of terms.

18:33If you as a GP find an investor with deep enough pockets for the size of the fund you want to raise, who's also willing to participate on, let's say, skinny terms. Because fundamentally, all these terms have evolved over time due to the market, due to the demand of either the GP side or the LP side, right? And so as a manager, and we're talking here about building a long brand, a long longevity in terms of your fund approach, I think it is important to, yes, lots of things on the internet and you read through the useful guidance that have been issued by various advisory groups, law firms, etc.

19:10and really valuable insights around data sets, etc. But I think ultimately getting into the weeds of it and actually understanding the intricacies of these terms, that will only happen as you're living and breathing those negotiations yourself. And I think the more you do that as a manager, I would say if you're a successful manager and remain a successful manager, I would have expected you have gone through that process multiple times. Yeah. Then let's go directly into where is it absolutely important that a manager prioritizes their time and their money spent and where can they not just lean over to the LPs or say, okay, I'm going to copy paste this clause or this part of my LPA because it's probably going to be fine.

19:57I, you know, I think that it's really important to get a good set of documents in place. You know, oftentimes I'll hear people say, well, can I save money by not doing a private placement memorandum? I mean, you can, but what that document does is really protect you as a sponsor, because you're telling your potential investors, these are the risks associated with investing. You know, oftentimes sponsors don't want to say, well, you could lose all your money because I don't want to scare my investors. I don't want to tell them all the bad things that can happen. But that's standard. It's market.

20:34And it protects you by saying, hey, here's what could happen. But at the same time, it's an opportunity to sell yourself because in this document, you're also talking about your great strategy, your track record, you as a person, why they should invest with you, you know, selling yourself. So it's not only a promotional document, but it's also a document that is protective of you. And so I tend to not like to see people skip that because it is dual purpose. And spending a little bit more money now will save you a lot of headaches in the long run. Do you agree, Karma? Yeah, yeah, absolutely. I'd also add, you know, we can talk about this subject in so many different ways.

21:16But I think the one thing that's always absolutely critical, if you want to save time, money, is making sure you've got two things locked down as tight as you can, I think, as a manager. One is absolutely crystal clear on your strategy, knowing what that looks like. You can say, I do early stage in this vertical. that's fine too but actually drill down whenever you can to a deeper level if you if you look at it internally as a team because that will play a part later in the the amount of money you can deploy into certain areas right and sometimes you have buffers you can go outside the strategy it also plays a part in the narrative you build with your lp base so the more differentiated more clear more disciplined you you appear in your strategy the better i would say and then the other is the team you know being absolutely clear about the value that each of your team members bring especially the principal founding group, the management, the senior level, because again, that plays its role in the legal terms, because we have key executive provisions, which are critical in the discussions you're going to have with your LPs.

22:17And so knowing who are your key persons, is there different tiers of them? All of that feeds in to the legal contract as well. And LPs do care about that a lot. And of course, they care about it, because it's about the commercial output, your ability to execute your strategy well or not, it's predicated on the basis of your team. Could you expand on that being super clear? How does having had these discussions, having had this very well defined, how does that play into the legal set of documents? I mean, oftentimes the investors will want to see these are, for example, the three key people. They're investing because they believe in those principles, those key people.

23:03So what happens if one goes or two goes, leaves the business? You know, investors will lose faith. And so sometimes we have, we strongly recommend key person provisions in the documents, which legally spell out what happens if one of the three leave? What happens if two of the three leave? You know, do you go to the investors at that point and offer a new principle? You have to sell it to them so that they still have faith that their money should continue to be invested. You know, oftentimes when someone when one of these key principles leaves, there's a suspension of the ability of the fund to make new investments while you convince your limited partners that, hey, this new principle is great.

23:48They can continue or the remaining principles themselves have enough skill and expertise to continue the strategy. And so that's something that's very key in these documents. Is this a place where you see people skipping or where you think the standard is too often just applied and not nuanced to the particular case? I think sometimes sponsors are surprised at who the investors think are critical on the team. And sometimes it can lead to a little bit of internal strife where a big investor is like, you know, I really want karma, but I don't think he's not that essential. You know, so sometimes your ego gets a little hurt, you know, when you're one of the key players or you think you're a key player.

24:33But your investors really do dictate to you who they have the most faith in, because oftentimes if there's three, they could say those two could leave. but karma can't. If karma's gone, we have to stop and we have to really rethink this. And so it is really important. And it's also part of your sell. When you're selling to the investors, who are the leads, who are critical to the strategy? And so that's something to really think of in advance. And it's part of what you sell to the limited partners. And then they'll expect to see that in the documents. And it also goes towards your team dynamic and being aware as you go through your multiple funds, how your team is being added to and reshaping itself because that will play a part in the next fund that you launch and the key person provisions around that as well.

25:22Any other places where you say it's absolutely important that you prioritize your time and money in the beginning? It's really the economics, making sure that you are very clear on your economic terms. you know, oftentimes, you know, investors are going to want something special. So let's say, you know, any, even an existing successful manager will have investors come in and say, hey, if I give you X number of dollars, which may be very big for your fund, they're going to want something special in return. And it's typically special economics. They want a lower management fee. They want a lower carried interest.

26:03They may want some other, you know, transparency, et cetera. And so understanding that you may have to give them a side letter with these special provisions sometimes can be challenging for sponsors because they don't want to give up that. And they have to decide, can they give up part of that management fee? And if you're not really established, it is hard to reduce your management fee. So you may choose to reduce your carry in the long run, because that's also alignment. The better you do for the investor, they'll take that reduced carry. Maybe you can talk a bit to what's kosher and what's not kosher when we think about special provisions.

26:51It's really interesting when you're an emerging manager, I think everything's on the table. Oftentimes your big investors are going to dictate to you what the terms are going to be and what they're willing to accept. I think the key is oftentimes we'll see people get that big seed investor to get them launched and to expand, to do bigger things. And those seed investors will often want longer term contracts than just this fund. And so you get really, we see sponsors get really excited. Oh my gosh, this investor is going to give me 50 million, a hundred million. And this is, these are the terms they want.

27:29Be very careful about how it's drafted because oftentimes the seed investors are going to want priority and better deals on your next fund. And you really need to, you know, think through what are you giving up long-term? And that's where, you know, lawyers can really come in, you know, helpful to say the way this language is drafted, they have rights to the second, the third, the fourth fund. Is that really what you want to give? So let's think through that. And these are highly negotiated bespoke, but it's really important not to get too excited about right now and think, how is this going to impact me in the future?