Venture capital funds (“VCs”) have extensive legal and regulatory disclosure and reporting obligations to supervisory authorities and their investors. This applies to VCs that are subject to licensing requirements. However, even VCs that are not subject to such requirements have similar obligations, albeit to a more limited extent.
The contractual provisions regarding the disclosure of information
In addition to these obligations, there are also contractual disclosure and reporting obligations to investors. These obligations are set forth in the fund documentation; depending on the fund’s legal structure, they may be found in the Limited Partnership Agreement (“LPA”), the fund rules, or the members’/participation agreement. For the sake of brevity, I will refer to these documents as the LPA hereinafter.
The LPA is the legal cornerstone of the contractual relationship between the investors, the fund, and the fund manager. It sets forth in detail the rights and obligations of the investors and the fund manager. The right to information and reports is one of those rights. This is an exceptionally important right because, without information, investors cannot monitor their investment or take timely action to protect it.
When Interests Clash
As with any contract, even with an LPA—no matter how precise and comprehensive it may be—ambiguity can arise regarding exactly what has been agreed upon. Situations may also arise that the LPA does not anticipate. While investors have an interest in maximum transparency, the manager may have (legitimate) reasons for not providing information (without restriction). For example, information may be confidential, price-sensitive, or competitive; it may relate to other investors; it may be subject to a confidentiality agreement; or it may harm the fund’s negotiating position, and so on.
Where are the limits of the duty to disclose information when there is uncertainty or gaps in the agreements, or when a conflict arises between the interests of the investors and other relevant interests regarding the disclosure of certain information? Should the manager look beyond the text of the LPA, and should he proactively provide additional information in special cases? And how much information can an investor reasonably expect to receive?
A dilemma that requires careful consideration and decision-making
The manager’s disclosure obligations can therefore present him with difficult dilemmas and require him to continuously and carefully balance the interests of the investors against all other relevant interests. This assessment must—in addition to the contractual frameworks—be based on the requirements of reasonableness and fairness, as well as the duty of care that the manager must exercise toward the investors. Among other factors, it is relevant that there is an information asymmetry between the manager and the investor; investors rely on information provided by the manager to make their decisions. The contractual frameworks therefore do not always define the limits of the duty to disclose.
This assessment by the administrator always involves an element of subjectivity. After all, another administrator might make a different decision under the same circumstances. It is therefore important that the manager—in situations where he chooses not to share important information—carefully assess the situation, possibly with external legal advice, and thoroughly document the grounds for the decision. If a dispute arises with the investors regarding this matter, the manager must be able to explain how he weighed the options and how he arrived at his decision.
When should you be on your guard?
There are certain situations in which a failure to provide information properly could result in civil liability for the administrator. For example, if:
Other situations in which the manager must consider whether to provide investors with immediate and additional information—regardless of the contractual agreements—include, for example:
· a portfolio company is on the verge of collapse or is facing a crisis of any kind;
· A major change is imminent within the manager's management team;
· the valuation of a portfolio company changes suddenly and substantially;
· the manager establishes another fund;
· the administrator knows that an exit is coming;
· A serious conflict arises within a portfolio company or within the fund manager’s management team.
In conclusion
For Investors
Private/non-professional investors in particular—for whom complex fund documentation is not always easy to understand—would be well advised to 1) familiarize themselves with the existence, nature, and content of their rights to information, and 2) exercise those rights (pro)actively. These rights have been granted in their best interest for good reason. At the same time, these rights are, of course, not unlimited. When a material development occurs, it must be assessed whether a claim can be made for more or different information than was contractually agreed upon.
For the administrator
The recommendation for fund managers is to 1) not treat investors’ rights to information lightly; 2) think beyond the contractual framework; and 3) in the event of material developments, conduct a careful and documented assessment of whether, when, and what additional information should be shared.
