Launching a fund on AngelList? Read this first
TL;DR: If AngelList acts as your GP, then you could lose your fund and your carry. Luckily, there are easy ways to avoid this risk.
I’m a former venture-backed founder and current venture fund lawyer at Lidow PC, a law firm devoted to emerging venture funds. This post is about surprising risks that I came across while helping a client launch an AngelList-Advised fund.
If you are an emerging venture fund manager (“EM”) launching your first or second fund, you’re probably considering using AngelList for your fund’s launch and admin.
There are good reasons to use AngelList, but there are some risks to consider as well, and they haven’t been flagged or discussed anywhere that I can find. My goal here is to share a handful of the risks we found in AngelList’s offerings so that you can avoid, or at least be aware of them, when you launch your fund.
The biggest risk in my eyes - and the one I’ll pick apart below - is that AngelList structures some of its fund products in a way that could cause you to lose control of your fund and lose your carry under some not-so-crazy scenarios. My personal opinion (fleshed out below) is that there is a >5% risk of you losing control of your fund and carry within a 10 year fund life. And for you, that might be a very large loss.
The good news is that there are ways to avoid this risk, both with AngelList and through other options. And if you already launched a fund on AngelList-Advised and want to clean up these risks, which is easy to do, schedule a quick call with me here.
Before you dive in:
AngelList and Carta frequently update their products - this post is based on one experience with their products and documents in May 2023, and my opinion as a lawyer, investor and member of the venture community.
I have a few more important things to share (too much for this post) so please subscribe if you’re starting a fund and want to benefit from the experience of someone who has recently gone through this process:
Why we started with AngelList
My client was drawn to AngelList because they’re the dominant brand for aspiring fund managers and they’ve been in the market for a long time. They’ve got a well tested platform for running a fund, and they offer speed and simplicity - you can start a fund in weeks, and it’s about as easy as opening some bank accounts.
That’s great for everyone who might not have the bandwidth to fully understand the legal structures and processes involved in starting a fund. But AngelList has achieved this speed and convenience by putting an impressively simple UI and user journey over a very complex system with a lot of surprising details.
How most AngelList funds work beneath the surface
AngelList has four different fund products - Base (“best for funds under $3M”), Core (“best for funds $3M-$30M”), Institutional/Full-Service, and Institutional/Admin-Only. While it’s not clear why they do this, AngelList allows you to use “an AngelList entity as your fund's GP and advisor” for all of those products except Institutional/Admin-Only.1
So what does that mean? A standard venture fund is a limited partnership, which is a type of business entity that has a General Partner (GP) who manages the partnership and several Limited Partners (LPs) who invest money but don’t participate in management. The GP manages the fund, invests the capital and, in return, receives carried interest (carry) in the investment returns. The GP also has the right to control the partnership, and can only be over-ridden or replaced in a few narrow situations (like loss of a key fund manager). These rights that the GP holds in the fund are considered personal property, and cannot be easily taken away from the GP.
When AngelList acts as your GP, AngelList controls the fund and invests the capital, and benefits from those rights that cannot be easily taken away. But, wait… this is your fund - aren’t you supposed to control it?
To give you that experience of control and ownership, AngelList hires you (or a management company that it forms for you) as an investment advisor. You sign a “Sub-Advisory Service Agreement” with AngelList under which you get to recommend to AngelList (who is ultimately responsible for investment decisions) what investments to make. In return, you get paid the management fee. You (or your management company) are also brought into the fund as a Limited Partner (who doesn’t control the fund) to receive carry.
Which gets us to how you might lose control, and your carry
When AngelList is the GP of your fund and you are its investment sub-adviser, AngelList can fire you. In the version of AngelList’s Sub-Advisory Service Agreement that I reviewed, AngelList could terminate the contract if the EM’s management company:
breached that agreement;
breached any letter of intent with AngelList;
breached the limited partnership agreement of the fund;
breached the TOS of any service provided by AngelList or any of its affiliates; or
was involved in, or suspected by AngelList of being involved in, shady business dealings (which the SEC calls participating in a “disqualifying event”).
If any of those things happen in your relationship with AngelList, AngelList can remove your ability to recommend investments to the GP and, surprisingly, can take away and keep your carry.
Of course there are strong reputational reasons for AngelList not to do that - AngelList is a growing brand that doesn’t want to be known for taking away its customers’ funds and carry. But remember that this is a decade-long relationship, and AngelList may have very different incentives in a decade. It may, for instance, have been sold to a private equity chop shop that’s not interested in preserving the brand but is very interested in retaining your carry.
In addition to the risk that a future AngelList might abuse its right to fire you and take your carry, there’s a fairly common situation in which they might be required to fire you, even if they don’t want to. If AngelList is the GP of your fund, they have a fiduciary duty that requires them to protect your funds’ LPs from you if AngelList believes that you are a “bad actor” under SEC rules. Becoming a “bad actor” is a common occurrence (the SEC pursues hundreds of cases every year) and can be triggered by some things that you might not expect (like forgetting to make a single annual filing). AngelList might need to fire you if it even suspects that you’re a “bad actor” in order to uphold its own fiduciary duties to your fund’s LPs - even if the SEC hasn’t taken issue with you.
Here’s how to think about and value that risk
All of the risks I listed above are pretty unlikely to happen over a 10-year fund life. AngelList probably won’t have been sold to predatory PE firms for scraps, won’t decide that it’s a good idea to abuse its client relationships, and won’t get nervous about whether you’re a “bad actor” (provided that you file your annual compliance forms and don’t do anything sketchy). So if you do choose to let AngelList act as your GP, then odds are pretty good that things will go smoothly for you.
But when you add up the probabilities of the various risks I described above, I think there’s at least a 5% chance of realizing at least one of these risks in the next 10 years. If that happens, the consequences could be very expensive for you. After all, you’re starting a fund because you think you’ll be good at it, and being good at managing a venture fund means earning lots of carry.
Here’s how I think about valuing that risk: being good at VC means a >3x return on your fund. Assuming your fund has market terms, >3x return means that your carry should be >40% of your fund size: >$4M for a $10M fund. A 5% chance of losing >$4M in future carry should be meaningful to you today (>$90K in present value to you). It’s certainly worth paying a few thousand dollars, or spending some additional time, to avoid.
Here’s how to avoid it without significantly increasing cost or complexity
The good news is that it’s very easy to avoid risking your control of your fund and your carry. The best thing to do (which you know by now) is to control your GP, and there are two good, fully supported ways to do this.
Stick with AngelList but go with their “self-advised funds” offering. While AngelList acts as your GP in its Base product, it’s possible to opt into a “self-advised” version of its Core or Institutional offerings. This allows you to form and control a traditional fund and GP, while taking advantage of AngelList’s software and admin capabilities.
Check out Carta. Carta has a similar fund formation and admin product that costs $17K-20K per year. Its major benefit is that you control your own GP (the whole point of this post), and its major downside is that it doesn’t handle annual tax filings for your fund, or SEC/state regulator filings for your fund or management company.
If you go with Carta, you’re going to want an outside accountant for tax filings, and a lawyer for your compliance filings and some deal-related work. The total annual cost of those accounting and legal fees should be under $10K. Together with Carta’s admin fee, this is a bit less expensive than using AngelList.
Or, if you’re feeling really brave, DIY. Setting up your own fund is not that much more complicated than doing your own taxes, it should only take you a few days work, and you will truly understand the workings of your own fund. There’s also a whole ecosystem of accountants and back-office service providers to help you out, possibly for less than the bigger players charge. I plan to post a full checklist in plain english with the templates that you’ll need, for anyone who wants to try to DIY.
In conclusion - go start a fund
Do what you need to do to get your fund up and running. Momentum is important, and the purpose of this post isn’t to slow you down or derail you. AngelList and Carta are two good resources for you. But be aware of the risks of letting someone else act as the GP of your fund.
If you want to read about other important insights for EMs, subscribe:
Thanks for reading! If you’re an EM or aspiring-EM and need help launching or running a fund, schedule a call with me here. My law firm, Lidow PC, is devoted to working with EMs like you.
It’s possible to use AngelList’s “Institutional/Full-Service” and “Core” products with your own GP, even thought that is not clear from their pricing and feature comparisons, and doesn’t appear to be the default for that product.