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Legal Framework for Limited Partners in Israeli Venture Capital Funds


Israel’s vibrant venture capital (VC) sector offers attractive opportunities for investors, including foreign limited partners (LPs) and Israeli institutions. However, investing as an LP in an Israeli VC fund requires understanding the local legal and regulatory landscape. This overview outlines the key legal entities, laws, regulators, tax considerations, compliance obligations, and the protections/limitations affecting LPs in Israeli VC funds.


Fund Structure: Limited Partnerships and Key Entities

Limited Partnership Vehicle: Israeli VC and private equity funds are typically formed as limited partnerships under the Partnerships Ordinance [New Version], 5735-1975arnontl.com. This structure involves at least one General Partner (GP) and multiple Limited Partners (LPs)barlaw.co.il. The GP (often a corporation or management company established by the fund managers) manages the fund’s operations, while the LPs are the investors who contribute capital.


Roles and Liability: In an Israeli limited partnership, the GP has unlimited liability for the partnership’s obligations, whereas each LP’s liability is limited to the amount of their capital contributionlexlink.orgpw-law.co.il. This means an LP risks only the invested amount and is generally shielded from additional debts if the venture failspw-law.co.il. Crucially, LPs cannot take part in the active management of the partnership’s business – if an LP does engage in management, they could be treated as a GP with full liabilitylexlink.org. The GP exclusively controls investment decisions and day-to-day fund management, which is why fund agreements often reinforce that LPs are passive investors.


Partnership Agreement: The fund’s constitutional document is the Limited Partnership Agreement, which outlines the commercial terms and governance of the fundbarlaw.co.il. While many rights and rules are defined by this agreement, the Partnerships Ordinance also provides certain default provisions for GP-LP relationships (e.g., rules on admitting new investors or dissolution) that apply unless the partnership agreement stipulates otherwisebarlaw.co.ilbarlaw.co.il. In practice, LP agreements commonly include bespoke terms such as restrictions on GP actions, LP advisory committees, transfer rights, and mechanisms for LPs to remove the GP for cause or early terminate the fund, giving investors additional protections beyond the statutory defaultslexology.com.


Key Laws Governing Israeli VC Funds

Partnerships Ordinance (1975): This law governs the formation and operation of partnerships in Israel, including VC fund partnerships. It sets out definitions and rules for general vs. limited partners, registration requirements, and partner duties. For instance, it codifies that limited partners’ liability is capped at their investment and that they must not manage the businesslexlink.org.


No Dedicated VC Fund Law: Unlike some jurisdictions, Israel does not have a specialized statute for venture capital or private funds. Aside from regimes for mutual funds and funds investing in publicly traded securities, there are no specific fund formation or fund manager licensing regulations targeting private VC/PE fundsarnontl.com. In other words, Israeli law does not require a general partner or fund manager to obtain an investment advisor or fund manager license so long as the fund does not engage in regulated activities or public fundraisingarnontl.comlexology.com. (Notable exceptions include funds that conduct regulated business such as providing credit, which would require a financial services licenselexology.com.)

Securities Law (1968) – Fundraising Rules: The Israel Securities Law, 5728-1968 and its regulations apply to how fund interests (limited partnership units) can be offered to investors. By default, any offering of securities to the public in Israel requires an ISA-approved prospectusarnontl.com. Limited partnership interests in a fund are considered “securities,” so offering them broadly would be a public offering unless an exemption is usedarnontl.comarnontl.com. Practically, Israeli VC funds rely on private placement exemptions to raise capital from LPs without a public prospectus. The two primary exemptions are:


  • Qualified Investors Exemption: An unlimited number of offers can be made to “Qualified Investors” – essentially accredited/sophisticated investors (as defined in the First Addendum of the law, based on financial thresholds or institutional status) – provided procedural safeguards are followedarnontl.comarnontl.com. The ISA requires confirming each investor’s qualified status (through certifications at offer and admission stages) to ensure they can fend for themselves without public-offering protectionsarnontl.comarnontl.com.


  • Limited Offerees Exemption: Offers can be made to a limited number of non-qualified investors, not exceeding 35 offerees in any 12-month periodarnontl.com. This “35 investors rule” means that even if some prospective investors ultimately do not invest, they still count toward the 35 if they were approachedarnontl.com. Exceeding 35 non-qualified offerees (even by mistake) would violate the public offering prohibitionarnontl.com. In practice, most Israeli funds raise only from institutional or high-net-worth investors, or carefully limit any non-institutional offerees to stay within this cap.


These exemptions allow Israeli VC funds to avoid full securities registration, but they come with compliance steps (e.g. obtaining investor declarations) and are overseen by the ISA’s guidance and enforcement. The ISA has published position papers detailing how fund solicitations should be conducted to remain within the private offering safe harborsarnontl.comarnontl.com.

Regulatory Bodies and Oversight

While Israeli VC funds operate in a relatively laissez-faire regulatory environment compared to public funds, several government bodies are involved in oversight:


  • Israel Securities Authority (ISA): The ISA is the securities regulator charged with enforcing the Securities Law. For VC funds, the ISA’s main role is to police fundraising activities. The ISA ensures that funds do not illegally offer securities to the public without a prospectus. It monitors compliance with the private placement rules (such as the qualified investor and 35-offeree exemptions) and has issued guidelines on how fund managers may approach investorsarnontl.comarnontl.com. Notably, a private VC fund itself is not required to register with or be licensed by the ISA as long as it avoids a public offering and doesn’t trade public securitiesarnontl.comarnontl.com. The marketing of fund units must simply conform to the law’s exemptions. If a fund were to breach these rules (for example, by general advertising or exceeding investor limits), the ISA could take enforcement action. In summary, the ISA provides indirect oversight by setting the boundaries for fundraising, but does not directly regulate day-to-day operations or investments of a private VC fund.


  • Registrar of Partnerships: The Israeli Registrar of Partnerships (a unit of the Ministry of Justice) is responsible for the legal registration of partnerships. Every limited partnership must be registered with the Registrar within 30 days of formationlexlink.org. The registration process entails submitting the partnership agreement (in Hebrew) and details such as the partnership’s name, names and addresses of the GP and LPs, each LP’s contributed capital, and the partnership’s term and objectivesjdsupra.comjdsupra.com. The Registrar issues a certificate of registration, giving the partnership legal recognition. While the Registrar does not supervise investment activities, partnerships must file notices of any changes (e.g. new partners, changes in capital commitments, or a change of general partner) to keep the public register updatedlexology.com. There is an initial registration fee and an annual fee for maintaining a partnership on the registerjdsupra.com. The Registrar can reject or require correction of filings that don’t meet legal requirements, but it does not evaluate the fund’s financial soundness or business – its role is mainly to ensure proper public disclosure and legal status of the partnership.


  • Israel Tax Authority: The Tax Authority oversees the taxation of fund entities and investors. VC funds in Israel are generally treated as tax-transparent partnerships, so the Tax Authority’s primary concern is that partners correctly report and pay tax on their share of the fund’s incomelexology.comlexology.com. For foreign LPs, the Tax Authority plays a proactive role by issuing advance tax rulings or guidelines that clarify their tax liability (or exemptions) when investing in Israeli funds. In recent years, the Tax Authority has promulgated circulars outlining conditions under which foreign investors in VC/PE funds will be exempt from Israeli taxes on certain incomelexology.comlexology.com. The authority may audit funds or investors to ensure compliance with these rulings and general tax laws. Additionally, the Israeli Tax Authority administers any required withholding taxes (though in partnerships, distributions are generally not subject to withholding at the fund levellexology.com). In summary, the Tax Authority’s oversight ensures that funds and LPs adhere to Israeli tax laws and benefit properly from available tax incentives or treaty relief.


Other bodies may become relevant in specific contexts. For example, if a fund’s strategy implicates regulated sectors (like financial services, defense tech, or fintech), other regulators (such as the Supervisor of Financial Services for credit fundslexology.com) might have jurisdiction. However, a conventional VC fund investing in private tech companies is not subject to routine financial regulatory supervision, apart from the general frameworks described above.


Tax Considerations for Foreign and Domestic LPs

Pass-Through Taxation: Israeli VC funds structured as limited partnerships are not subject to entity-level tax on the fund itselflexology.com. Instead, the partnership is fiscally transparent – each partner is taxed on their allocable share of the partnership’s income as if the partner earned it directlylexology.comlexology.com. Consequently, Israeli LPs must report their share of gains, income, or losses from the fund on their own tax returns. For Israeli individual investors, such income could be taxed at rates up to the top marginal rate (approximately 47%-50% for high earners) depending on its characterlexlink.org, while Israeli corporate investors are subject to the corporate tax rate (23% as of 2020) on their share of partnership profitsherzoglaw.co.il. Israeli institutional LPs that are tax-exempt entities (like certain pension or provident funds) remain tax-exempt on fund income, provided they meet conditions in the tax law (e.g. the “control and holdings” tests under Section 9(2) of the Income Tax Ordinance)herzoglaw.co.il.


Foreign LPs – Exemptions and Rulings: Israel actively encourages foreign investment in its venture sector by offering favorable tax treatment to foreign LPs. In general, non-Israeli residents are exempt from Israeli capital gains tax on sales of Israeli securities (such as shares of startups) if they have no permanent establishment in Israellexology.comlexology.com. Dividend and interest income sourced from Israel may be subject to withholding tax (often 25% on dividends, and 15%-25% on interest, subject to treaties) in the absence of special arrangementslexology.com. However, Israeli policy has evolved to give foreign investors in qualified VC or private equity funds even broader relief:

  • Advance Tax Rulings: It is common for a new VC fund to obtain a ruling from the Israel Tax Authority confirming the tax treatment of its foreign LPslexology.com. Under a typical ruling, foreign investors are assured they will not be deemed to have an Israeli permanent establishment or tax residency solely by investing in the fund, and thus they will not be required to file Israeli tax returnslexology.comlexology.com. The ruling also usually provides that foreign LPs are exempt from Israeli tax on capital gains from the fund’s investments (especially in Israeli high-tech companies, which often qualify as “venture capital investments”)herzoglaw.co.il. Israeli-source dividends or interest that the fund receives and allocates to foreign LPs may be taxed at reduced rates or exempt under the ruling, often aligning with treaty rates or special 0% rates for certain types of foreign institutional investorsherzoglaw.co.il.

  • Tax Circular Conditions: The Israeli Tax Authority has published guidelines (Income Tax Circulars) setting out conditions a fund should meet to grant foreign LPs these tax benefits. Key conditions include having a minimum number of investors, a substantial percentage of foreign capital, a cap on any single investor’s ownership share, and significant investment in Israeli companies or Israeli R&D activitiesherzoglaw.co.ilherzoglaw.co.il. For example, one circular requires at least 10 unrelated investors, at least ~$10 million in commitments with $5 million from foreign investors, no one investor (with one exception) over 20-35% ownership, and at least 30% of the fund invested in Israeli tech companies or startupsherzoglaw.co.ilherzoglaw.co.il. If these criteria are met, the Tax Authority will generally rule that gains from Israeli “Qualified Investments” are tax-free for foreign LPs, and other income (like interest or dividends) is taxed at low rates or not at all for certain foreign investor categoriesherzoglaw.co.ilherzoglaw.co.il. Notably, income from the fund’s non-Israeli investments is fully exempt from Israeli tax for foreign investors in any caseherzoglaw.co.il.


Under such approved arrangements, foreign LPs typically do not have to pay Israeli tax or even file Israeli tax returns on their fund incomelexology.comlexology.com. The fund’s Israeli GP or management entity handles any necessary Israeli tax compliance, such as reporting to the Tax Authority and ensuring the fund adheres to the ruling’s conditions. Distributions from the partnership to foreign LPs are generally not subject to Israeli withholding tax either, since the income was exempt or already accounted for via the rulinglexology.com.

Carried Interest and Management Fees: Though primarily affecting the GP and managers, it’s worth noting how these are taxed as it can indirectly impact LPs (e.g. via fund expenses or alignment incentives). Management fees paid to the GP or a management company are treated as ordinary income, taxable in Israel at regular rates (corporate or personal) depending on the recipientlexology.com. Carried interest (the GP’s share of profits) is given special tax rates under typical rulings: foreign GP members often pay a flat 15% tax on carry from Israeli investments (and 0% on carry from non-Israeli investments)herzoglaw.co.il, while Israeli GP members face a blended rate (often around 25% on the portion of carry attributable to returns for foreign or tax-exempt LPs, and up to ~47% on portions attributable to Israeli taxable LPs)herzoglaw.co.ilherzoglaw.co.il. These rules ensure the GP’s compensation is taxed, but at incentives-aligned rates, and they do not impose any tax burden on the LPs themselves.

Finally, Israel’s network of double taxation treaties (with the US, UK, EU countries, etc.) can further reduce or eliminate Israeli withholding taxes on certain income for foreign investorslexology.comlexology.com. Many treaties confirm that a partnership’s income is only taxable in the partner’s home country if the partner has no permanent establishment in Israel – reinforcing the benefit of the Tax Authority’s ruling that the fund does not create a taxable presence for foreign LPs. Overall, the tax framework is highly favorable for foreign LPs, aiming to make investing in Israeli VC funds as frictionless as possible from a tax perspective, while ensuring domestic LPs pay their due share.


Formation, Registration, and Compliance Obligations

Formation and Registration: Establishing an Israeli VC fund as a limited partnership is a straightforward legal process. The founders (GP and initial LPs) must draft and sign a written partnership agreement, and then register the partnership with the Registrar of Partnerships. The registration involves submitting a notice that includes key details: the partnership’s name, its general partner and limited partners, each LP’s capital commitment, the partnership’s purpose (e.g. venture investments), and whether it’s for a fixed term or open-endedjdsupra.comjdsupra.com. The partnership agreement itself must be filed (with an official Hebrew translation if originally in another language)jdsupra.com. Upon paying the required fee (approximately ₪2,653) and filing the documents, the Registrar will record the partnership and issue a certificate, typically within a weekjdsupra.com. Notably, foreign partnerships or LLCs acting as the GP must also register in Israel if they are not Israeli entities, and a foreign partnership operating in Israel must appoint a local representative to receive official noticeslexlink.org.


Ongoing Compliance: Compared to corporations, partnerships have relatively light ongoing compliance duties. Nonetheless, an Israeli fund partnership must update the Registrar of Partnerships whenever certain changes occur – for example, if the partnership’s name or address changes, if the GP is replaced, or if new limited partners are admitted or an LP transfers their interestlexology.com. Any increase in an LP’s committed capital or other material amendments to the partnership agreement should also be reported. An annual fee must be paid to maintain the partnership’s active status on the registerjdsupra.com. There is no requirement for public financial reporting (unlike public companies, partnerships do not have to publish financial statements), but the partnership will prepare financial statements for its partners and tax filings.


Because Israeli VC funds are not regulated by a specific authority, they do not have regulatory reporting obligations to the ISA or other agencies (aside from tax reporting). However, general laws still apply. Fund managers must observe anti-money laundering (AML) and know-your-customer norms when onboarding investors, ensuring that the source of funds is legitimate and investors are not sanctioned persons. Although a typical VC fund manager might not be classified as a “financial institution” under Israeli AML laws, banks and service providers will require KYC checks on LPs, and any suspicious activities must be reported under Israel’s Prohibition on Money Laundering Law.

Investor Reporting and Governance: While not mandated by statute, it is standard practice for the GP to provide LPs with regular updates on the fund’s performance. Typically, the partnership agreement will require the GP to deliver annual audited financial statements and periodic reports (quarterly or semi-annual letters) to all LPs. The GP may also convene an annual general meeting of partners or maintain an advisory board of LP representatives to consult on key issues. These practices ensure transparency and help the GP fulfill its fiduciary duties. If the fund obtained a Tax Authority ruling, it must also comply with any ongoing conditions (for example, filing periodic confirmation that investment thresholds are met or that no single investor exceeds the allowed percentage). Non-compliance with a tax ruling’s terms could jeopardize the fund’s tax benefits, so fund administrators carefully monitor adherence to those requirements.

In summary, Israeli VC funds must handle basic corporate housekeeping (maintaining registration and paying fees), tax compliance (partnership tax returns, investor tax withholdings if any, and meeting ruling conditions), and internal reporting to LPs, but face minimal regulatory bureaucracy compared to funds in many other countries.


Legal Protections and Limitations for LPs

Investing as an LP in an Israeli fund comes with specific protections under the law, as well as inherent limitations on the LP’s role:

Limited Liability: The foremost protection is the LP’s limited liability status – an LP cannot lose more than their agreed capital commitment. Israeli law explicitly defines a limited partner as someone who contributes a specified amount and “is not responsible for the obligations of the partnership beyond the amount he invested”pw-law.co.ilpw-law.co.il. This shields passive investors from personal exposure to the fund’s debts or lawsuits. Creditors of the partnership cannot demand payment from limited partners (beyond any unpaid capital commitment). This protection holds as long as the LP remains passive. If an LP were to take an active management role, they risk being treated as a de facto general partner and losing their liability shieldlexlink.org. Therefore, LPs must refrain from day-to-day decision-making or holding themselves out as agents of the fund.

Fiduciary Duties and Information Rights: Israeli partnership law imposes fiduciary duties on those in control of the partnership – primarily the GP – for the benefit of the other partners. The GP owes the LPs a duty of utmost good faith, loyalty, and full disclosure. Under Section 29 of the Partnerships Ordinance, partners must manage the business for the “collective benefit” of all partners, be honest and faithful to one another, and provide every partner with accurate accounts and information on all partnership mattersgornitzky.comgornitzky.com. In a 2024 case, the Tel Aviv District Court affirmed that due to the imbalance of power (LPs contribute capital while the GP controls the business), a GP has an enhanced fiduciary obligation toward LPsgornitzky.com. This includes avoiding conflicts of interest and disclosing any personal interest or benefit the GP has in partnership transactionsgornitzky.comgornitzky.com. If a GP breaches these duties – for example, by concealing fees or diverting partnership opportunities for itself – the LPs have legal recourse. They may sue for breach of contract and fiduciary duty, and even seek a court-ordered dissolution of the partnership on grounds of unfair conductgornitzky.comgornitzky.com. These fiduciary protections incentivize the GP to act transparently and in the best interest of the fund.


Contractual Rights: Many protections for LPs are spelled out in the negotiated partnership agreement rather than statutes. LPs typically benefit from affirmative rights such as approval rights on certain major decisions (e.g. extending the fund’s term, increasing the fund size, or replacing the GP). It is common to have an LP advisory committee of unaffiliated limited partners to review conflict-of-interest transactions or valuation matters, adding a layer of oversight. The partnership agreement may also allow a supermajority of LPs to remove the GP for cause (e.g. for fraud, gross negligence, or regulatory disqualification) and appoint a new general partner or accelerate the fund’s dissolution. Additionally, LPs usually have information rights in the contract – the right to receive financial reports, and sometimes the right to inspect the fund’s books and records upon request. Israeli law provides that, by default, a limited partner can assign (transfer) their partnership interest to another party, who then steps into the same rights as the original LPbarlaw.co.il. In practice, the partnership agreement often restricts transfers (requiring GP consent or offering other LPs a first refusal) to preserve the fund’s stability, but an LP can at least exit by selling their interest if a buyer and the contract permit.

Limitations on LPs: By design, an LP’s influence on daily operations is limited. Statutory law prevents LPs from participating in management, which can be frustrating for investors who want control, but it is the trade-off for limited liabilitylexlink.org. An LP cannot unilaterally withdraw their capital or dissolve the partnership except as provided in the agreement or law. In fact, the Partnerships Ordinance’s default rules state that a limited partner cannot dissolve the partnership by mere notice (unlike a general partner or a partner in a general partnership)barlaw.co.il. The duration of the fund and terms of dissolution are agreed upfront, meaning LPs are locked in for the fund’s life unless extraordinary circumstances or agreement amendments allow an earlier exit. Furthermore, LPs rely on the GP’s expertise and integrity; they cannot dictate which startups to invest in or how to manage the portfolio. Their remedies if dissatisfied are indirect – they can vote to remove the GP if the contract allows, or ultimately pursue legal action for misconduct. From a legal standpoint, LPs are thus in a passive, trusting position: their protection comes from the GP’s fiduciary duties and the carefully negotiated terms of the partnership, rather than any hands-on control.

Despite these limitations, the Israeli legal framework and market practices strive to balance power between GPs and LPs. By ensuring full disclosure, aligning incentives (through carried interest and co-investment by GPs), and giving institutional LPs certain oversight mechanisms, the system protects LPs’ economic interests while preserving the GP’s ability to manage effectively. For foreign LPs, additional comfort comes from knowing that their legal relationship is governed by a well-established Israeli partnership law and that disputes can be adjudicated in Israel’s reputable court system (or via arbitration, as many fund agreements specify) without political bias.

Conclusion

Investing in Israeli venture capital funds as an LP means operating within a legal framework that emphasizes flexibility, private ordering, and investor protection through limited liability and fiduciary accountability. The primary fund vehicle – the limited partnership – offers a familiar GP/LP structure with clearly delineated roles. Israel’s laws, notably the Partnerships Ordinance and Securities Law, enable VC funds to function without heavy-handed regulation, provided they raise capital privately and abide by general legal standards. Regulatory bodies like the ISA and Registrar of Partnerships ensure that fundraising and legal formalities are handled properly, while the Tax Authority provides mechanisms to minimize tax frictions, especially for foreign investors. LPs enjoy the benefit of limited liability and are safeguarded by the GP’s duties of loyalty and transparency, even as they cede control over management.


For foreign investors and Israeli startups alike, this framework has proven conducive – it encourages the flow of global capital into Israeli innovation by offering legal predictability and favorable tax treatment. At the same time, it holds fund managers to high standards of conduct. By understanding these key elements of the Israeli VC fund legal environment, LPs can invest with confidence, knowing the rules that govern their rights and obligations. As always, prospective LPs should conduct due diligence and consult legal advisors when joining an Israeli fund, to ensure the partnership agreement and any tax rulings fully address their needs. With the right precautions, the Israeli VC ecosystem provides a robust yet flexible platform for limited partners to participate in the “Startup Nation’s” success within a sound legal and regulatory framework.

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