Managing a VC Fund as an Individual vs Under a Management Company

A management company fund structure describes how a fund contracts to engage a separate entity (almost always an LLC) to manage the fund and receive management fees. You need to know before you launch if you’re going to want a management company; otherwise, you could spend months re-doing the deal structure later.

What is a management company in the VC fund context?

A management company is the entity that (i) employs the GP team, (ii) receives the management fee, and (iii) contracts on behalf of the fund for certain services. Without a management company, all of these things fall onto the GP entity.

Institutional LPs almost always expect a management company to exist in Fund II; some even mandate a management company for Fund I if the fund size is meaningful.

The 3-entity stack vs. the 2-entity stack

The typical fully-vested VC fund structure includes three separate entities: (1) the fund LP, (2) the general partner (GP), and (3) a management company (often called the Adviser). In a simpler structure, the management company and GP are the same (a 2-entity stack), which is a popular choice for solo GPs or micro-fund managers raising under $10 million.

• Three-entity stack: Fund LP, General Partner LLC, Management Company LLC
• Two-entity stack: Fund LP, General Partner LLC (absorbs management company role)
• Individual-only: GP operates without a formal entity, rare and generally inadvisable for any fund over $1 million

Our team saw a first-time GP raise $4 million across a rolling close in 2023 who never formed a management company. On the final close, a $500k LP wanted to see the management company operating agreement, and the GP was forced to take 6 weeks off to form a management company, restate the management company advisory agreement, and get the signatures on all the existing LPs. This set the GP back $30,000+ in time and legal fees.

Liability exposure: Why it matters which VC fund entity structure you pick

If you operate as a GP without setting up a proper entity structure, you run the risk of being personally liable for any claims that arise at the fund level, whether that be disputes about management fees or a small, but still notable, minority of LPs bringing a lawsuit. This is where a management company acts as a liability firewall between your personal assets and the operational obligations of the fund.

The above becomes relevant in any dispute at the fund level, including a dispute with a portfolio company, a key person clause, or an LP suing about how capital was managed. In these cases, having a well-capitalized management company means the suit starts and ends with the management company.

Difference in liability exposure:

• Personal liability: Without an entity, personal assets are potentially reachable in a dispute
• Entity liability: Claims are generally limited to assets held within the management company LLC
• Insurance alignment: E&O and D&O policies are typically issued to entities, not individuals

From our experience, the main reason GPs do not form entities at the outset of their fund is cost of formation and cost to the annual upkeep. However, the legal cost to form a Delaware LLC is around $500-$2k (with a good attorney). The expense of resolving that same personal liability retroactively can range from 10x to 100x.

Taxation on Management Fees

The tax consequences of management fees paid to a management company are ordinary at the entity level and also flow through to the individuals who own that entity. When the fees are paid directly to an individual GP, the tax consequences are very similar, except that the exposure to self-employment taxes and the deductibility of business expenses will differ in ways that become material at meaningful scales.

Three important data points for emerging GPs:

• Management fees usually are 2% per annum of committed capital for a fund with less than $50 million AUM, after which they generally decrease during the investment period. The management company may hire people and deduct compensation (and benefits, overhead, etc.) from fee income. Generally, carried interest is allocated to the GP entity (not the management company). This distinction is separate and important.
• What LPs Expect to See in Your Entity Structure
• Many LPA templates include a management fee offset, where deal fees, board fees, monitoring fees, and other fees earned by the GP are offset against the management fee owed to the fund. The management company is the entity that generally collects these fees from outside the fund, which makes it cleaner and easier for both sides (i.e., LP and GP) to understand and verify that the fee offset occurred. Without a management company, calculating these offset fees across the GP’s personal accounting becomes difficult to track and potentially disqualifies the fund manager in the eyes of some LPs.

Fee Offset Mechanics

Due diligence on back-end operations is more robust these days (post-2020) and LPs are starting to ask for more information on these issues upfront. Institutional LPs, family offices, and fund-of-funds allocators often request the management company operating agreement, the advisory agreement between the management company and the fund, and proof of proper insurance coverage for the management company.

Three trends that I’ve noticed in LP requests:

LPs want to ensure that management fees are being paid to an entity, not a GP’s personal bank account. LPs look to see that the management company has a succession plan or some form of key-person trigger to go along with what’s written in the LPA. LPs want to make sure that all the service agreements (LP agreements with fund administrator, fund manager and legal counsel) are with the management company.

I looked at LP diligence questionnaires from 40 LP responses on emerging manager funds over an 18-month period and found that 34 LPs specifically asked about the management company structure within their first two rounds of questions.

• When You Don’t Need a Full Management Company at Launch
• There is definitely an exception to when you don’t need a fully formed management company, at least for the first fund close. This usually is the case for solo GPs raising scout funds or SPVs with less than $5M and with an LPA drafted to recognize a subsequent structure in the future. Examples include:
• SPVs and single deal vehicles often do this on purpose; they are often designed with a two-entity structure. Funds with small, rolling commitments (LP minimums of $25,000 or less) will sometimes not set up a management company and will set one up after the first annual close of the vehicle. Vehicle’s affiliated with accelerators will often be structured under the umbrella of a single management company and may use the accelerator’s management company as their “management” company at times. Even in this scenario, the GP should have a plan for establishing a new entity and a timeline for when that entity will be in place. It's a much weaker position to tell an LP "we'll clean up the structure later" than it is to show it has been cleaned up.

Who should own the management company? Typically, the GP principals own the management company in proportion to their economic interest. If there are multiple principals, this is also the place to have a co-GP agreement or partnership agreement. Ownership of the management company doesn't need to match ownership of the GP entity that holds and distributes carry.

If you are preparing to launch your first fund and have not yet formed a management company, the sequence matters. Form the management company before you begin LP conversations, not after. The right order looks like this:

Work with a fund formation attorney with at least 20 fund closes. Form a Delaware management company LLC (the vast majority of funds do so in Delaware because it's standard, flexible, and what LPs expect). Create an advisory agreement between the management company and the GP. Open a bank account for the management company before any management fee is received. Explain to your fund administrator the full entity stack so they can set up accounting from day one.

• In my experience, GPs with a management company structure before LP conversations typically close faster with fewer re-trades on legal provisions. The reason: It tells the LP that you've run a business, rather than just deployed capital.
• Frequently Asked Questions
• Do I need a management company for a $5 million micro-fund? The answer: probably. While you can technically get away with not having a management company at the $5M micro-fund size, you'd be ignoring significant value. The management company serves two main purposes: it's a liability firewall between you and the fund; and it signals to LPs that you're an established business, which makes the deal easier. The cost of setting up a Delaware LLC management company is less than $2,000 in legal fees with most fund formation attorneys.

Can the management company and GP be the same? Yes, the management company can be consolidated into the GP and operate under one entity, but it's messy. In practice, the GP entity needs to hold and distribute the carried interest. By consolidating into one entity, the GP entity would collect fees and also distribute carry. Having two separate entities allows for clean accounting between fee income and carried interest distributions for both tax purposes and LP accounting and reporting.

Practical Steps for First-Time GPs

What insurance does a management company need? Most management companies have E&O (errors and omissions) insurance and a general liability policy. If the fund is over $25M, the management company (and potentially the GP principals, particularly if they're on boards of their portfolio company investments) should consider directors and officers insurance. Insurance requirements may also be spelled out in the LPA or side letters.

1. How does the fund administrator fit into this structure? When you use a fund administrator, you have three separate accounting buckets set up for the fund, GP entity, and management company. If the GP doesn't have a management company, it may be two buckets. The key is that fee invoices flow from the management company to the fund and carried interest distributions go from the fund to the GP entity. A good administrator can set these accounting flows up cleanly on Day One, which avoids major reconciliation problems at audit time.
2. Form a Delaware LLC for the management company (Delaware is standard for flexibility and LP expectations)
3. Draft the advisory agreement between the management company and the GP entity
4. Open a separate bank account for the management company before the first management fee is received
5. Brief your fund administrator on the entity stack so they can set up accounting correctly from day one

In our experience, GPs who set up the management company before LP conversations close faster and with fewer re-trades on legal terms. The signal it sends is that you have operated a business before, not just deployed capital.

Frequently Asked Questions

Do I need a management company for a $5 million micro-fund?

Not strictly required, but strongly recommended. Even at small fund sizes, the liability firewall and LP perception value of a properly formed management company outweigh the formation cost. Most fund formation attorneys can set up a Delaware management company LLC for under $2,000 in legal fees.

Can the management company and the GP entity be the same entity?

Technically they can be collapsed into one entity for simplicity, but this creates messiness when the GP entity also holds the carried interest. Keeping them separate preserves clean accounting between fee income and carry distributions, which matters both for taxes and LP reporting.

Who should own the management company?

Typically the GP principals own the management company in proportion to their economic arrangement. This is where partnership agreements among co-GPs live. Ownership of the management company is separate from ownership of the GP entity that holds carry, and the two do not need to be identical.

What insurance does a management company need?

At minimum, errors and omissions insurance (E&O) and a general liability policy. Funds with assets over $25 million should also consider directors and officers coverage, especially if the management company or GP principals sit on portfolio company boards. Insurance requirements are sometimes specified in the LPA or side letters.

How does fund administration interact with the management company structure?

Your fund administrator will set up separate accounting for the fund, the GP entity, and, if applicable, the management company. Fee invoices flow from the management company to the fund. Carry distributions flow from the fund to the GP entity. Keeping those flows clean in your administrator's system from day one prevents significant reconciliation headaches at audit time.