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 the common DAO in the cryptocurrency market. This article is based on the column article “A Brief Discussion on Risk Investment #2: Common Investment Entities” by DAOSquare, compiled, translated, and written by Foresight News.
Introduction
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) of the United States for more information on types of business entities.
Partnerships
Partnerships are structures where 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 LLPs 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 venture capital field. Therefore, we will only introduce general partnerships and limited partnerships.
General Partnerships (GP)
General partnerships are the simplest structure where two or more people share the management and personal liability of a business. It is the simplest structure that can be chosen when partners establish a business. Establishing a general partnership is simple, requiring only registration of a name, obtaining an EIN number, and formulating and signing a partnership agreement. Due to the low operating costs, no need for state filing, no application fees, and no franchise taxes, GPs have been used by tens of thousands of investment clubs.
In a general partnership, all partners bear personal responsibility 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 with the lowest ongoing operating costs, but partners bear higher personal risks.
Limited Partnerships (LP)
Limited partnerships are the most common legal entity in the venture capital field, with most funds using limited partnerships as their legal entities. We can quickly understand what a limited partnership is by understanding the roles, responsibilities, and liabilities of partners in the actual venture capital business.
Limited Partner (LP): These partners are investors who provide funds to the fund and are also known as 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 only bear relevant liabilities within their investment proportion.
General Partner (GP): 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. Therefore, they are also known as venture capitalists. Unlike limited partners, general partners have unlimited liability.
Usually, general partners and limited partners sign a Limited Partnership Agreement (LPA) to detail their relationship and terms, 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 its legal entity, it is recommended to consult the relevant departments in the local jurisdiction.
Limited Liability Company (LLC)
There are many reasons to form a limited liability company instead of a partnership, including liability and ownership roles. Most importantly, LLC provides the benefits of both a corporation and a partnership structure to business owners. This makes LLC 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 features:
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, with 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).
Enhanced Credibility: Compared to general partnerships, limited liability companies can help new businesses establish reputation more effectively.
In the investment field, powerful investment clubs may adopt LLC as their legal entity to better protect the personal assets of each member. Additionally, if an institution serves as a general partner in a fund executed by a limited partnership (LP), the general partner usually also 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 the risks of fund debts or litigation.
However, the drawback of establishing a limited liability partnership or limited liability company is that their establishment and operation costs are higher than partnerships. They require payment of organizational fees and ongoing expenses, as well as the need for a lawyer to draft articles of organization, among other things.
Special Purpose Vehicle (SPV)
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 an entity structure that can be established as a limited partnership (LP) or a limited liability company (LLC). It is important to note that SPV is usually a concept relative to the parent company, meaning that SPV is often an independent entity separated from the parent company.
SPVs are also commonly used in the venture capital field. SPVs can help funds or venture capital firms achieve more flexible investment operations. For example, when a specific investment project does not align with the investment ideas of the fund or investment company, limited partners or company members can voluntarily choose whether to join the SPV. Additionally, isolating specific startup investments within an SPV can protect the investment from the risks associated with other investments held by the fund or venture capital firm. For investment funds and investment companies, SPV is a very flexible and practical tool.
The biggest difference between SPVs and traditional venture capital funds is that SPVs invest their entire capital in one company, while traditional venture capital funds or investment companies invest in multiple companies that meet the fund’s investment themes in different stages and industries. Also, 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 period of time because the realization of returns depends only on the exit of one company, such as through acquisition or IPO.
DAO (Decentralized Autonomous Organization) can be simply 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 also begun to use DAO tools to establish and execute on-chain funds. Compared to traditional fund execution models, DAO has demonstrated its advantages in many aspects, such as:
Funds are held in smart contracts, providing investors with more security for their funds and amplifying the credibility of fund financing.
Partnership agreements and fund rules executed based on smart contracts provide greater protection for investors’ interests while reducing the operational and management costs of the fund.
It is obvious that DAO has more advantages than mentioned, but it is beyond the scope of this article. We will write a separate article to introduce it.
The legal status of DAO may vary depending on the jurisdiction where it operates. Currently, some jurisdictions may recognize DAO as a legal entity, while others may not have specific regulations or laws for DAO yet. Therefore, if you plan to establish or participate in a fund executed through DAO, it is recommended to consult the relevant authorities 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, Marshall Islands, and others. As crypto gains support from more legal jurisdictions, DAO is likely to become a technologically driven emerging entity category.
To recap:
General Partnership (GP): Two or more people share the management and personal liability of a business, the simplest structure that can be chosen when partners establish a business. Due to its simplicity and low cost, it is widely adopted by most investment clubs in the United States.
Limited Partnership (LP): Composed of general partners and limited partners. It is the most common legal entity in the venture capital field, with most funds using limited partnerships as their legal entities.
Limited Liability Company (LLC): Owners (or members) of LLCs 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 limited partnerships (LP) often adopt LLC as their legal entity.
Special Purpose Vehicle (SPV): Allows multiple investors to pool funds and invest in a company. It is an entity structure that can be established as a limited partnership (LP) or a limited liability company (LLC). The main difference between SPV and traditional venture capital funds is that SPV invests its entire capital in one company, with a shorter exit time.
Decentralized Autonomous Organization (DAO): DAO is an organizational type based on code execution. Compared to traditional entities, DAO has demonstrated numerous advantages and has the potential to become a technologically driven emerging entity category.
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