European Fund Domicile | Travers Smith

Earlier this month the FT picked up on a report by an academic from the University of Glasgow which concluded that the rise in the use of non-UK funds has resulted in reduced transparency. The resulting debate implied shadowy motives and underplayed legal and regulatory drivers. What hasn't been highlighted is how this plays out for venture capital. When VC GPs ask "where should I put my next European fund?" they often reach different conclusions to those in other parts of the private capital eco-system and we think that is interesting.

There is no doubt that across private capital strategies as a whole, the use of the English limited partnership is in decline. Indeed, back in 2021, the Johnson administration consulted on what could be done to stem the tide. There are a number of reasons for the fall off.

The key issue is regulatory. UK funds cannot, as a result of Brexit, use the EU marketing passport. This makes it much harder to easily access a pan-European investor base. Marketing into specific EU jurisdictions is possible under local "national private placement regimes", however these are not really a substitute for the passport because they are not available in some key locations. Even where permitted, they require the house to make separate applications for each jurisdiction.

Luxembourg also has a more sophisticated range of fund structures. It has been nimble in updating its "toolkit" to respond to market demand, for example, facilitating compartmentalisation and making it easier for GPs to access different legal forms. In practice, having a variety of structuring options is less relevant to venture strategies (credit is a heavy user), but it allows Luxembourg to stake its claim to be the all-singing, all-dancing onshore fund jurisdiction.

Those regulatory drivers mean that some larger VC sponsors do favour Luxembourg. They may already have infrastructure there and are better able to bear the high service-provider costs. They see access to the marketing passport as an important benefit, and value the prestige that comes from being located in the same jurisdiction as many other leading private capital sponsors.

However, outside of the largest VC sponsors, we do not see significant numbers choosing Luxembourg.

        
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    "In practice, having a variety of structuring options is less relevant to venture strategies (credit is a heavy user), but it allows Luxembourg to stake its claim to be the all-singing, all-dancing onshore fund jurisdiction."

The Channel Islands remain popular for venture capital funds with GPs pointing to the twin advantages of cost and familiarity. Jersey and Guernsey are established fund jurisdictions and are generally less expensive than their onshore competitors to operate from. The Channel Islands' continuing appeal to venture capital funds bucks the trend we see elsewhere in private capital fundraising.

But the issue that often gives GPs pause when considering the Channel Islands is: how do their LPs feel about investing 'offshore'?

Certain large European institutional investors (particularly, some DFIs (development finance institutions) – who are a key player in the European VC industry) cannot or are reluctant to invest in funds domiciled in offshore jurisdictions. As a result, our experience is that sponsors considering a first fundraise may be reluctant to choose the Channel Islands (subject to the appetite of their investor base), and (in line with other alternative asset classes) we have seen some established VC players onshoring their fund structures in response to these considerations.

For many sponsors (including lots of major players), the UK remains the European jurisdiction of choice in the venture space, with a significant number of fundraisings still taking place in the UK. The UK is "onshore" and investors are familiar with it. In addition, it has greater service-provider capacity than Luxembourg and is less expensive. More generally, VC sponsors that are used to raising UK funds, are familiar with the associated drawbacks, and there has been no great trend in them looking to use foreign jurisdictions for their recent funds.

This discussion would not be complete though without talking about VAT. Not very interesting perhaps, but increasingly significant. Somewhat counterintuitively, there is a VAT incentive for UK sponsors to situate their funds abroad and this favours Luxembourg and the Channel Islands. Those sponsors do not have to charge VAT on fund management supplies they make to their non-UK funds and have better VAT recovery on their costs. The UK government is aware of this, but – to-date – considers the cost of the fix unpalatable.

So, for European private capital generally, we have a move away from the UK and Channel Islands, and towards Luxembourg and, to a lesser extent, Ireland. But when you drill down into venture capital, those trends are less pronounced. Both the UK and the Channel Islands remain popular and the move towards Luxembourg is less significant. Much turns on the size of the manager.

We'll finish with one to watch. Although Ireland is a well-established financial services hub, it is not currently a popular destination for VC fund domicile. This may change. Historically, Ireland's attractiveness has been hampered by the clunkiness of its Investment Limited Partnership (ILP) and 1907 LP structures. However, following a series of reforms, the ILP is more viable. On top of that, in practice, Ireland is less expensive and administratively easier to use than Luxembourg, with better service provider capacity and more efficient processes (e.g. in relation to anti-money laundering compliance). It could become a serious competitor to Luxembourg for EU-based VC funds.