At Tuck I have taken a couple of classes on VC investing, and though they have done a good job teaching deal structure they never really delved into how a fund was structured or managed. This may be because it varies greatly from firm to firm, but it meant that I really didn’t understand a lot of how a fund was actually operated. So today I had lunch with the funds operations controller, in an attempt to learn a bit more about the inner works of a VC partnership.
The standard fee structure for PE and hedge funds is 2/20, the LP’s take 2% of the fund to run the day to day operations, and 20% of the profits. Now a fund with a proven track record may be able to get better terms, it is rumored that some of the top VC funds got 35% at the height of the bubble, but as a rule of thumb 2 and 20 prevails.
Lunch led to a couple of insights that I found to be interesting, the first is that the 2% isn’t always on the amount committed, but instead is sometimes on net asset value (NAV). The thinking by LP’s is that they should have to pay 2% on money that has already been invested and returned. Of course this makes it more difficult for the VC, since the amount of money they have to ‘keep the lights on’ is now variable, so they prefer the more static, and lucrative, 2% of fund size.
The second thing I learned seems obvious in retrospect, but it had never occurred to me before now. If you’re taking a fee of %2 of the fund each year, that turns out to be 20% of 10 years. So some of the money received from early wins will need to be recycled back into the fund to get to deploying 100% of the funds value.
Very interesting stuff that I didn’t hear about in school.