Venture capital funds are widely recognised as performing a crucial intermediation role in the start-up sector, as they are capable of pooling capital from various investors, both individual and institutional, and in turn make early stage investments into portfolio companies. Conventional wisdom regarding venture capital funds often indicates that the limited partnership is ubiquitous as the preferred business form for venture capital funds. It allows venture capitalists to act as general partners and engage in the management of the fund, while investors act as the limited partners with limited interventional capabilities in the control of the fund.
Scholars have lauded the limited partnership as an appropriate vehicle for venture capital funds, referring to it as ‘venerable’ and as ‘the single most important organizational innovation of the modern venture capital system’. The limited partnership has been widely accepted in the American venture capital arena, and there have been calls for a widespread application of the US-style limited partnership by other countries, especially in Europe.
Further, legislatures in some jurisdictions have hastened the introduction of the limited partnership, while in others they have sought to modernize existing limited partnership structures to suit evolving business needs. For instance, jurisdictions such as China, Singapore, New Zealand, Taiwan, Japan and Switzerland have introduced the limited partnership over the last decade, while others such as the United Kingdom, the British Virgin Islands and Australia modified their limited partnership law to meet changing business requirements. This has propelled the limited partnership to be the dominant business form globally.
The other business vehicle for venture capital is the trust, which has not received as much attention despite its suitability for the purpose. While the trust originated under the Anglo-American tradition, the concept has now been transposed to several civil law jurisdictions as well. Yet, the trust has not received much traction as a business form for venture capital, especially when compared with the proliferation of limited partnerships across various jurisdictions.
Against this background, several questions emerge. Is there a specific business form that is optimal for funds and essential to constructing a successful venture capital market? If so, is the limited partnership the most optimal business form? Can other business forms, such as the trust, act as functional alternatives to the limited partnership and help engender a vibrant venture capital market?
In a forthcoming paper, we seek to address these questions through a comparative study of the business forms that are dominant in the Chinese and Indian venture capital markets. Venture capital has thrived in both markets despite the fact that venture capital funds in each jurisdiction adopt altogether different business forms, viz, the limited partnership in China and the trust in India. Recognizing the importance of limited partnerships to venture capital fund raising, the Chinese legislature introduced the limited partnership under the Revised Partnership Enterprise Law, which was effective from 1 June 2017. Conversely, venture capital trusts in India are governed by an age-old legislation in the form of the Indian Trusts Act, 1882, and the Indian legislature has yet not found the need to introduce a limited partnership structure.
Using the examples of China and India, we argue that the presence of specific business forms, while important at the outset, is not determinative of the growth of the venture capital market if there are functional equivalents that can substantially achieve the goals of investors and managers. Where multiple organizational forms are available under law, parties are likely to choose the optimal one (eg the limited partnership), as evident from the Chinese experience. However, where only one business form is eminently suitable (eg trust), parties are likely to nevertheless adopt it despite minor inefficiencies, as long as it provides the same benefits as the dominant (absent) form, as the Indian developments demonstrate.
Lin Lin is an Assistant Professor at the Faculty of Law of the National University of Singapore.
Umakanth Varottil is an Associate Professor at the Faculty of Law of the National University of Singapore.