Following from here, if a member chooses to invest in a deal through our groups, they face two fees.
- An “additional contribution” to cover future costs of the investment’s administration
- A “carried interest” on a profitable investment outcome
1) We run all investors’ commitments through one “investment entity” (a Delaware Series LLC) which becomes a shareholder of the portfolio company. This is good news for the entrepreneur (one entry on your cap table), for the investor (one Schedule K1 for this year’s investment activity, even if you did 10 deals, at tax time), and for us (one entity to administer, not one separate entity for every investment).
Unfortunately, creating an investment entity costs a surprising amount. Fees include:
- Filing and formation fee in Delaware ($200)
- Delaware registered agent fee ($50)
- A certificate of authority to do business in SC or NC ($110 or $250) plus payment for a DE certificate of good standing ($50) to get that
- State Securities / Attorneys General filings (the state version of the SEC Form-D) in SC or NC ($300 or 350)
- Drafting (or recycling) of articles of incorporation and other formation documents, which for the first time might cost $500-$2,000 of attorney’s fees
And keeping it running costs even more:
- Delaware franchise taxes and annual report ($300 per year)
- Delaware registered agent fee ($50 / year) ongoing
- NC annual report ($200 / year) – and an extra $2 for filing it electronically! (SC doesn’t require one of these)
- Preparing and filing tax returns. Though our sponsors do these as efficiently as possible, it nonetheless costs $3,000-$6,000 per year to prepare the tax returns and provide investors with their Schedule K1s.
Even winding them up costs money – $204 in Delaware plus $10 more for SC!
So over five years, that’s $30,000+ – regardless of how little we invest. Not to mention the time sunk into filing documents, reviewing tax returns, recordkeeping, and firefighting. We get little productive work done in March because of all the tax returns!
The additional contribution we require for an investment is held to pay for these costs (and other direct entity- or investment-related costs) over an estimated investment life of five years. If the additional cash is not used (e.g. if we have a quick exit, or a quick write off), they are refunded to the investor; and if there is a profitable exit, these costs are returned before the calculation of carried interest. (We collect it upfront because we don’t want to run out and therefore need to chase members, some of whom may have left, for $25 each year.)
The operators of the group don’t make money from these contributions. They’re the regressive taxes required to make early stage investments – a tax seemingly on us and our investors, but ultimately the tax burden is on the early stage companies that we are trying to funding. Not obviously the group you should tax if you want a dynamic entrepreneurial economy and “innovation hub“, but that’s modern regulatory compliance for you.
2) Carried interest – we’ll tackle that next.