Cover Story: Work in Progress –

Venture firms raising funds this year face one of the most contentious fund-raising environments since the mid-1990s – a period much like today when LPs pushed through a host of changes in how they work with venture firms. Even experienced firms will find that they must rewrite or renegotiate key aspects of how their limited liability companies operate.

Despite an upswing in stock prices, a return of mergers and acquisitions, a modest recovery of venture-backed IPOs, and a generally more favorable outlook on private equity investing, limited partners sense that they have the opportunity to redress the excesses of the Internet boom. Except for the very top venture firms, just about everyone else who is fund-raising will need to develop a new private placement memorandum (PPM) and governing agreement, the two documents underlying venture funds. Drawing up the new documents means that VCs will have to reconsider issues as varied and contentious as fee attenuation, joint and several liability, and no-fault divorce in a fund termination.

In the old days a PPM was a short document hand delivered over coffee. Nothing fancy, just a solid short summary of the facts relating to a firm’s next fund offering. Many of the oldest and

most successful firms don’t even use PPMs for their largely hand-shake or phone-call based marketing of new funds. But for the majority of venture firms, 2004 is the year when PPMs and governing agreements have become a focal point for the most basic aspects of how they operate their businesses.

Today’s PPMs are approaching the formality of an IPO prospectus in substance and appearance. And with good reason, says Jonathan Axelrad, chairman of Wilson, Sonsini, Goodrich & Rosati’s Fund Services Group. “After the relative desert of the last two years, clients are coming in and talking about [preparing PPMs for] next year,” Axelrad says. And what he is telling them in light of the fights behind the closed doors of the once gentlemanly club of venture capital is that the PPM is no longer the marketing document of old. Now, he says, “The PPM is the front line of negotiations and litigation between general and limited partners.”

If anyone questions that assessment, “they should review the State of Connecticut’s lawsuit against Forstmann, Little,” which revolves around such issues as how Forstmann reportedly promoted itself in its PPM, says Marco Mosotti, a partner in the Investment Funds Group at Paul, Weiss, Rifkind, Wharton & Garrison. Another source says he’s aware of several instances in which a GP has sued an LP to “enforce capital commitment calls.” In every case the matter was settled out of court, the source says.

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