Most clients we work with have gotten the letter from time to time: “Hi, our firm is acting as agent for Institution X, one of your limited partners, who are selling a portfolio of interests in venture capital funds.” The letter goes on to explain that the manager’s interest has been selected to be sold, and – the big punch line – it asks the manager to “sign and return” the letter to authorize the release of the fund’s confidential information to prospective buyers. Usually, the letter will mention that an NDA of some sort is being signed by these prospective buyers.
Sounds safe, right? Not so fast. There are multiple issues to consider, and our first and foremost piece of advice for managers we work with is: don’t sign that letter.
The first issue is one of how broadly the manager’s sensitive information will be broadcast, and related, who will be the eventual buyer. The agent is ordinarily, though not always, paid in a percentage of sales fashion; and the seller of course receives the purchase price. So usually, to generalize, those parties don’t care all that much about the quality of the buyer – their sole incentive is to get the highest possible price.
The fund manager’s considerations are usually adverse to the goals of agent and seller. On the issue of how broadly the manager’s information is shared, most managers we work with tend to want to keep a tight lid on things – they would prefer their sensitive information go to a very limited pool of qualified buyers they would tend to accept as substituted LPs, and not be sent out broadly in a “spray and pray” type approach by the agent – which unfortunately we do see more often than you might imagine.
Perhaps more importantly, good managers work hard to optimize their LP base over time, favoring long-term participants who understand VC and can be a helpful asset to the fund, from the standpoint of providing knowledgeable LPAC members, to understanding the manager’s amendment and consent proposals, to helping the brand to maintain its allure over time for example both by the caliber of its name but also by reducing investor turnover in the fund. Since most VC partnership agreements cause the original investor to acknowledge that their interest in the fund is highly restricted as to transferability, and accordingly, give the fund manager broad discretion to consent (or not) to any transfer proposal, the fund manager has considerable leverage in the face of these sorts of letters from agents. In light of all of the above, most managers we work with will not agree to “sign the letter” and let the agent just run with the process.
So what to do in this situation? We recommend the following as the “gold standard” in terms of approaching a structured secondary sale run by an agent: the agent should enter into an agreement with the fund manager to which the underlying limited partner acknowledges and agrees, pursuant to which the agent commits to keeping any and all fund information confidential (this step establishes a direct contractual obligation of the agent to the fund manager, as opposed to needing to rely on the underlying partnership agreement and whatever it might say the limited partner’s responsibility is for the actions of their advisors). This “master agreement” with the agent will contain an exhibit which is the agreed upon form of NDA that a prospective buyer will need to enter into. The agent becomes required to present a list of proposed buyers to the fund manager, and the fund manager may then elect to approve one or more parties on that list. Once approved, the agent is free to go off and get the prospective buyer to enter into the agreed NDA, deliver a copy of the same to the fund manager, and then (and only then) disseminate the fund manager’s confidential information in initiation of the diligence process.
This procedure solves for the key considerations noted above that a typical fund manager is concerned about. First, it eliminates the chance for a “spray and pray” including to parties the fund manager would not accept anyway (competitors or others adverse, investors of dubious credit quality, investors that might invoke regulatory concerns, and so forth.). Second, it provides a chance for the fund manager to cull the list of prospective buyers to its preference. Will it take as a buyer secondary funds that don’t have primary programs to invest in the manager’s next fund? Difficult sovereigns or public pensions where the manager has tried hard to avoid those investors in its own fund raising? Third, it gives the manager robust contractual protection to dissuade the misuse of the confidential information – both in how it creates a direct obligation on the part of the agent, but importantly, also by enforcing the use of an agreed and acceptable buyer’s NDA.
As to that buyer’s NDA, there is often a question of whose form will be used. The agent will have a reasonable concern that if every manager insists on its own form of NDA, there is a very unwieldy process at hand (a prospective buyer of the “slate” of interests prior to starting diligence may have to sign numerous NDAs, which can be costly and impracticable). In the spirit of cooperation, many managers we work with will try pretty hard to go forward with the agent’s proposed NDA. However, there are boundaries, and in some cases, an agent (or underlying limited partner) presents an NDA that is so grossly unfair to the fund manager that pushback is necessary. A couple of good examples: a UK based limited partner in a Delaware domiciled Silicon Valley VC fund presents an NDA governed by UK law with dispute resolution in London; or an NDA that does not firmly establish the express third party beneficiary status of the fund manager to enforce its terms.
So, when you get that innocent looking letter – please think hard before just signing it. There are many important considerations to evaluate and you should focus on these issues before letting the agent and seller run freely with your sensitive information.