The two principal things you need to be concerned with are: (1) the business implications, and (2) the legal and tax aspects.
Prior to starting a VC or angel fund, think about what you want your fund to focus on. Different funds usually focus on different things. For example, some concentrate on due diligence or portfolio building while others aim solely at sourcing. Also, consider whether you’re primarily interested in early or later stage funding.
Additionally, make sure that you’re giving enough thought to market analysis. For instance, don’t think just of the product, but also of market share.
If you’ve identified a group of interested investors, you’ll need to draft a business plan. While much of it will share boilerplate features with those of non-VC businesses, you’ll need to pay particular attention to fee structures, capital commitments and a number of other items that have already been well listed in some of the other posts.
You should also educate yourself about the legal and compliance costs beyond formation. While establishing your entity might be relatively simple, the complexity and costs can mount significantly once you start getting into the business of securities regulation, deal structuring, tax planning and compliance, and assorted matters related to contractual obligations and other compliance areas (e.g., privacy and anti-money laundering requirements).
Engaging an experienced attorney or accountant – or both – before developing your business plan is also advisable. Professionals who are actively engaged in the focused practice of establishing and guiding funds with a financial and legal lens can yield a wealth of information. It’s extremely advisable to seek consultation services from accountants and attorneys who deal regularly with funds before you dive into the legal mechanics of setting up your firm.
If you’ve already done the groundwork and assembled your group of limited partners, your next step is to hire an attorney. Obtaining legal counsel to help you with deciding how to structure your fund and where to incorporate is crucial to building a solid foundation. Since much of the legal work relates to the tax code, you need a reliable tax attorney with a solid skill set in this line of work.
In general, VC funds establish an LLC to function as the management company and as the GP for the fund. The fund itself is usually structured as an LP, which hires the LLC as the GP. There are many reasons for using this structure, the most important being: (1) to shield LPs from liability, (2) to optimize tax advantages, and (3) to facilitate transactions.
You’ll often find that VC funds will use multiple LLCs and LPs in order to maximize business and legal advantages. Of course, if you need more than one of each type of entity, that will also drive up legal costs. However, this is one area you definitely don’t want to skimp on since there are numerous compliance issues that will affect how robustly you can do business, as well as multiple tax implications. Therefore, I’d not recommend this as a DIY project.
While you specifically ask about starting a VC or angel fund in California, a California attorney may advise you that incorporating in another state could be more advantageous. You would then need to file a fairly simple document with the California Secretary of State’s office that qualifies you to do business as a foreign entity in state.
The two most important startup documents are the operating agreement and the private placement memorandum. There are certainly a number of other documents involved information, but the operating agreement and memorandum have been the areas where I’ve seen costs mount the most quickly due to negotiating control rights and obligations. This is where the number and type of LP (limited partner) investors who are in your group will impact the legal costs of the transaction, which ranges anywhere from roughly $40,000 to $150,000 – again depending on where you incorporate and who’s in your group.
Funds are invested in the LP entity, which hires the LLC to manage the fund. There’s an enormous range of legal, tax and business complexity involved in doing this right, so hiring an experienced attorney is truly in your best interest.
ch offers more detailed guidance on how to consider sharing the equity pie with your investors. It’s not intended to provide legal advice, but there’s some pretty helpful information there that will give you a better idea of how to frame the concept of ownership, as well as how to allocate percentages.