How LPs Can Assess VC Fund Governance & Compliance Before Investing

This article is part of our 10-part series, Insider Secrets: What LPs Must Know to Invest in VC Funds in India, where we decode key insights for navigating this asset class with confidence. We’re also hosting an AMA on Feb 13 at 5:30 PM to tackle the critical questions LPs often overlook and uncover what aspiring VCs need to know but rarely hear internally. Register here.

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Governance and compliance are at the heart of a well-functioning venture capital (VC) fund. For Limited Partners (LPs), understanding governance structures and compliance mechanisms is essential to ensuring transparency,  mitigating risks, and safeguarding their capital.

This chapter explores key governance frameworks, the importance of oversight, and regulatory compliance considerations that LPs should evaluate when investing in a VC fund.

Verifying Ownership & Governance Structure Via MCA & SEBI 

Governance refers to the structure, policies, and processes that define how a VC  fund is managed and how investment decisions are made.

Strong governance ensures that the fund operates with integrity, aligns with LP interests, and adheres to best practices. 

Key Governance Elements In VC Funds 

• Fund Structure & Decision-Making
  • VC funds typically operate as Limited Liability Partnerships (LLPs) or  Limited Partnerships (LPs), where General Partners (GPs) manage investments on behalf of LPs.
  • Investment decisions are overseen by an investment committee,  ensuring strategic alignment.
• Transparency & Reporting
  • Regular financial reporting and performance updates keep LPs informed about fund activities.
  • LPs should ensure that reporting standards align with international best practices.
• Risk & Conflict Management
  • Funds must have mechanisms to identify and manage conflicts of interest.
  • LPs should assess whether GPs are incentivized to act in the best interests of investors. 

Best Practices In Governance For LPs 

• Ensure Clear Investment Mandates: LPs should review fund documentation to confirm that the investment thesis is well-defined and adhered to. 
• Assess Investment Committee Independence: An independent and diverse investment committee reduces bias and improves decision-making quality. 
• Monitor GP Accountability: LPs should evaluate how GPs are incentivized and whether their interests align with long-term fund performance.

Analysing Overlap Of Designated Partners & Senior Roles 

Compliance plays a crucial role in protecting investor interests and maintaining the integrity of the VC ecosystem. LPs should be aware of the key regulatory frameworks governing VC funds and their impact on fund operations. 

Key Regulatory Bodies & Guidelines 

• Securities and Exchange Board of India (SEBI):
  • When Regulates Alternative Investment Funds (AIFs) under the AIF Regulations framework.
  • Ensures transparency, investor protection, and fair governance practices.
• Financial Action Task Force (FATF) Guidelines-
  • Establishes anti-money laundering (AML) and counter-terrorism financing (CFT) regulations.
  • LPs should confirm that funds comply with AML policies.
• Fund-Specific Compliance Obligations-
  • Funds must adhere to KYC (Know Your Customer) norms.
  • Regulatory filings and audits must be completed per AIF regulations.

Due Diligence For LPs In Compliance 

• Verify Fund Registration & Licensing: LPs should check whether the fund is registered with SEBI or equivalent regulatory authorities.
• Review Compliance History: LPs should assess whether the fund has had past compliance violations or regulatory scrutiny. 
• Assess Fund Policies on Ethics & Governance: Ethical guidelines should be clearly outlined in fund documentation to prevent malpractice.

Implications Of Distributed Vs. Centralised  Ownership For LPs 

While many VC funds operate with integrity, LPs must be vigilant about governance failures that can jeopardize their investments. Some of the most  common governance red flags include: 

• Lack of Transparency 
  • No clear financial reporting or opaque disclosures.
  • Failure to provide regular LP updates on fund performance.
    
• Excessive Management Fees & GP Misalignment: Management fees that significantly exceed industry norms. • GPs focusing on short-term returns at the expense of LP interests.
• Conflicts of Interest & Unethical Practices
  • GPs having personal stakes in portfolio companies without disclosure.
  • Side deals that disadvantage LPs.
• High Turnover Among Key Fund Personnel
  • Frequent changes in the fund’s investment committee or management team.
  • Lack of experienced leadership in fund operations.
• Mitigating Governance Risks as an LP: To protect their interests, LPs should:
  • Conduct thorough pre-investment due diligence on fund governance structures.
  • Engage with fund managers regularly to monitor compliance and transparency.
  • Request periodic governance audits to ensure adherence to ethical and regulatory standards.

Conclusion & Key Takeaways 

1. Using Strong Governance is Essential: LPs must evaluate a fund’s governance structure to ensure decision-making transparency and accountability. 
2. Compliance Protects LP Interests: Understanding SEBI regulations and global compliance frameworks helps LPs mitigate regulatory risks. 
3. Be Aware of Red Flags: Lack of transparency, conflicts of interest, and excessive fees can signal governance failures that LPs should avoid.

This article is co-authored by Anup Jain & Rajeev Suri, Founder Partners @ BlueGreen Ventures