Incorporated Limited Partnerships for the Venture Capital Industry – new entity for the growing industry

 

By Clive Cachia of Gadens Lawyers – Sydney
email: ccachia@nsw.gadens.com.au

 

A Partnership Amendment (Venture Capital Funds) Bill 2004 was recently passed by the NSW Parliament.  Upon receiving Royal Assent, this Bill will match existing Victorian legislation (passed in December 2003) in providing for new corporate vehicles to raise venture capital funding.  The Bill establishes a new entity called an “incorporated limited partnership” (ILP). 

ILPs are common in overseas jurisdictions and are the favoured vehicles for venture capitalists seeking to invest in an investee company.  Unlike common law partnerships and “limited partnerships” established under existing statute, an ILP is a separate legal entity from its constituent partners with perpetual succession and may sue and be sued in its own name. 

A “limited partnership”, a common law partnership or any of the partners of such partnerships may apply to become an ILP under the Bill if the partnership is registered, or intends to register, as a Venture Capital Limited Partnership (VCLP) or an Australian venture capital fund or funds (AFOF) under the Venture Capital Act 2002 or is recognised or intends to be recognised as a venture capital management partnership” (VCMP) within the meaning of the amended Income Tax Assessment Act 1936.

Accordingly, this Bill should be viewed in the context of the Commonwealth Government’s establishment in 2002 of a range of tax concessions for the rapidly growing venture capital market. 

To re-familiarise, the Commonwealth Government passed legislation in 2002 providing for a more favourable tax treatment of entities attempting to attract international venture capital to Australia.  These new rules facilitated the following tax concessions:

·         Flow-through taxation treatment of limited partnerships that qualify as VCLPs, AFOFs or VCMPs.  This amended the previous position whereby limited partnerships were treated as companies for Australian tax purposes.  Hence, non-resident and resident investors can now claim deductions up to certain amounts of partnership losses.  This is extremely beneficial for venture capitalists as it allows them to offset early losses in one investment against income in another investment.

·         Certain non-resident investors (ie. those from Canada, France, Germany, UK, Japan and the US) granted a tax exemption for profits and gains from disposals of certain eligible venture capital investments.  An eligible venture capital investment is one which involves purchasing securities at risk by a VCLP or AFOF in an Australian investee company with gross assets of less than $250million and such an investment represents less than 30% of the limited partnership’s committed capital.

·         The carried interest (ie. entitlement of a general partner to a distribution from a VCLP or AFOF upon achieving a threshold of profits for the limited partners of that entity) in a VCLP, AFOF or VCMP is taxed on the capital rather than revenue accounts and are specifically excluded from fringe benefit tax.

The Bill provides for the initial step by which partnerships Venture Capital Limited Partnerships (VCLP's) are limited partnerships that meet certain qualifying criteria in accordance with two Commonwealth Acts, the Venture Capital Act 2002 and the Taxation Laws Amendment (Venture Capital) Act 2002. . However, a limited partnership will only be able to register as an incorporated limited partnership if it meets the criteria to be a VCLP, Australian Fund of Funds (AFOF) or a Venture Capital Management Partnership (VCMP) under the terms of the Commonwealth Acts.

Powers

As a separate legal entity, an ILP can perform various roles including:

·         carry on business of the partnership

·         enter into contracts

·         acquire, hold and dispose of real property

·         participate in trusts, partnerships, joint ventures or other arrangements

Given this distinct legal personality, much of the existing law of partnerships has no application to ILPs, its partners and their relationships.  In response, the Bill requires that there must be at all times a written partnership agreement between all of the partners.  Subject to the express requirements of the Bill, this partnership agreement will govern the relationships between the partners.

Limited vs general partners

Those familiar with “limited partnerships” will note that limited partners are the passive investors in the business and do not manage the business. They have liability for its debts and obligations only in proportion to the amount they invest. The actual management of the limited partnership is conducted by “general partners” who have unlimited liability for its debts and obligations. 

Express obligations of the partners in an ILP

Some of the more important requirements for ILPs under the Bill include:

·         Neither general partners nor limited partners are agents of each other and the acts of members of one type of partners do not bind members of the other type.

·         The persons authorised to do an act or execute an instrument for an ILP do not generally include a limited partner.

·         General partners are jointly liable with the ILP for its liabilities but that liability is limited to that which the ILP cannot satisfy or as otherwise provided for in the partnership agreement.

·         Limited partners limitation of liability to that amount initially invested by that partner in the ILP is qualified to the extent that the limited partner must not take part in the management of the ILP.  If the limited partner does so act, he or she is liable for his/her acts that cause loss or injury to a third party if that third party reasonably believed that the limited partner was a general partner.

·         However, there are “safe harbour” provisions which set out a variety of acts which may be conducted by a limited partner without being construed to be taking part in the management of an ILP.  The scope of these acts are quite broad and include accessing and giving advice regarding the books or overall financial status of the ILP and advising and assisting the investees of the ILP.  This is to protect limited partners who will take an active role in overseeing the investments the ILP makes.