Venture Fund Economics: Gross and Net Returns

The comments on my initial post on this topic went right at the VC’s compensation – management fees and carry – and their impact on returns. So at Ken Berger’s suggestion, I will change my planned post for today and address the issue head on.

The returns venture firms get on their investments are called "gross returns". I didn’t mention them in my post yesterday because I wanted to focus on the "net" returns to the LPs. I said 2x was the lowest attractive return on a venture fund and I meant net to the LPs. That means if you invest a dollar in the fund, you get two dollars back.

However, the fund has to get a lot more than $2 back on its investments to get its investors $2 back. That’s because before the investors get their money back, the fund takes a management fee. And if there are profits, the managers of the fund take a carried interest on the profits. Our fund takes 20% and that is the carried interest that most funds take. However, there are funds that charge 25% or even 30% carried interest fees. Some think the best funds charge the highest carried interest fees. Market theory would suggest that is true. But I am not sure that it is. I think we have a very good firm and we charge a standard carry. But that’s for another day, if at all. It’s a tricky subject to talk about.

The management fees don’t go directly to the fund managers. They pay for the costs of running the business. On small funds, that’s about all they pay for. On big funds, the management fees can get large enough to pay very significant salaries to the fund managers. Management fees are all over the map but range from 1.5% per year for large funds to 2.5% per year for smaller funds. And they typically tail off after the first five years to much lower percentages to reflect that the work of putting the fund to work is largely over.

The carried interest is only paid on gains. So if they fund makes no money, no carried interest is paid. But if the gains are large, the carry will be large too.

Back in 2003, when Brad and I started Union Square Ventures, we built a model of our fund to show how we thought the fund economics could work. At that time, we planned a $100mm fund. We ultimately raised a $125mm fund. But the model I am going to talk about is based on a $100mm fund.

Here are the base assumptions we made in our model:


I am not going to address all those assumptions in this post but if you have questions, post them in the comments and I will respond to them.

This model is basically our game plan. Some things changed in our execution of the fund, namely we raised $125mm, and we invested even less in the initial investment of "concept" investments, and we did more rounds for those really early stage companies. So we did 21 investments instead of 15 and we did more rounds of smaller amounts. But even though those seem like big changes, they did not effect the main drivers of fund capital allocation very much. It looks like the average investment amount will come in close to what we modeled and it looks like the capital allocation between seed, first round, and later stage investments will come in pretty close. Right now we are doing much better than 1/3, 1/3, 1/3 hit rate, but let’s wait until it’s all over to see how that comes out. You just never know in the venture business.

Here’s what this $100mm venture fund model produces:

Total Management Fees: $20mm

Total Invested Dollars: $80mm

Total Proceeds on Investments: $322mm

Total Gain on Investments: $242mm

GROSS Multiple: 4x ($322mm/$80mm)

GROSS IRR: 39.2%

Multiple Incl Mgmt Fees: 3.2x

Gain Incl Mgmt Fees: $222mm

IRR Incl Mgmt Fees: 32.9%

Carried Interest Fees: $44mm (20% of $222mm)

NET Multiple: 2.56x

NET IRR: 28.6%

So to make it really simple, a fund needs to get 4x (in this case $322mm on $80mm of invested captial) on its investments to generate 2.5x in distributions to its limited partners.

Paul Margolis of Longworth Ventures did a post a year and half ago on this topic and came up with similar numbers (although the difference between gross and net in his post are lower than mine).

The differences between gross returns and net returns are large in the venture and private equity business and it’s important to understand them and be clear about what numbers you are using when you talk about returns.

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Comments (Archived):

  1. Jens

    For carried interest, you mean that you net 20% of the money distributed to LPs after you have returned $100m to LPs?

    1. fredwilson

      In the case of this model, yes.But not all funds are required to return the entire amount of theirinvestors capital before taking carried interest feesSome are, including our 2004 fundfred

  2. Chris Yeh

    Fantastic post, Fred! I’ve been working with the venture industry since 1999 (and investing alongside VCs since 2003), and I’ve never seen anyone better explain the model behind one of their funds. Thank you.The most shocking stat was that carried interest only ended up being about 2X the management fees. I always thought the ratio was much higher. Given this fact, isn’t it important to the VC model to be able to make some money off the management fees?It also emphasizes what a good deal the hedge fund guys get.

    1. fredwilson

      The management fees should not be a source of compensation for themanagement of the fundIt should ³cover the rent² if you know what I meanIf you can make a bundle on management fees, why worry about carriedinterest?And that means non-alignment with the investors

      1. Steven Kane

        amenbut if truth be told the vast vast majority of funds and vc partners are basically earning little or no carry while making humungous gobs opf compensation on managment feesi mean, heck – with just $500MM under management, a firm is taking in around $10MM in managament fees per annum. that firm probably has 5-6 partners making investmentsbut the firm pushes off the cost of closing deals (legal costs) onto the LPs (via the portfolio companies) so whats left?maybe a dozen support staff (at say $175K/each on average all in, or $2MM/year)plus rent and utilities (maybe $500K/year)plus T&E (maybe $500K/year)…totals $3MM/year.say i’m way off and toss in another $1MM/year — new total $4MM total costs/yearand that still leaves $6MM year in management fees for the 5-6 partners to split… whether or not they ever earn LPs any return at all, let alone carry for themselvesthis is the typical VC firm these days. sure the top decile are making great returns for LPs, and ergo earned fortunes for themselves. but, just like the mutual fund business, the typical manager is earning huge comp while investors get fair or poor returns

        1. fredwilson

          I can’t argue with your mathOr your point

        2. blakeborgeson

          Thanks for that back-of-the-napkin math. Puts things in perspective.

  3. gregorylent

    thanks so much for this series

  4. Sam

    Fred,Thank you for being open. I enjoyed reading this article.

  5. shansinha79

    Fred- This is an unbelievably helpful post and subject. As an entrepreneur, we certainly understood that you were managing LP’s money, but this is the kind of detail that helps us understand you better. A few other topic ideas / questions for you: * what does a fundraising pitch look like for a VC pitching an LP? or What compels an LP to back you guys? is it mostly a people game (like raising early stage funding for a company), or is there something more to it? * what does the periodic LP meeting look like? * is there any way, with appropriate etiquette, for entrepreneurs to ask about details / economics of the current fund that would materially alter the likelihood of raising funding from a particular VC? * naturally, different fund structures based on the key metrics you describe above yield differentiation between different VCs. There are obvious ones (larger fund = larger average deal size = later stage/different industry investments). how do different values of the more nuanced metrics cause differentiation between VCs? For example, management fee pct., carry, or ratio of initial investment to follow-on investment

    1. Scott

      I think the fundraising pitch is largely based on the GP’s track record and how that will apply to the fund’s investment strategy.As for details of the current fund altering the likelihood of fund raising, my guess is that the age of the fund makes the biggest difference. A brand new fund is able to invest in startups that might have an 8+ year exit horizon, but a 5 year old fund is probably looking for a quicker hit since they’ll have to return LP money sooner.As for size of the fund, that sometimes affects investment stage preference, but more importantly it reflects expected outcomes – again, going back to fund strategy. A fund might put $10mm+ in a series A and/or B if it sees a realistic scenario of a 50x return on that capital. Mgmt fee is fairly similar between funds, but carry seems to be a function of performance – some hedge funds take 50% since they have such a good track record.

      1. shansinha79

        Thanks Scott. Yes I think your guesses are right.. but that’s about the depth to which I undestand the industry as well.For example, somehow, people who have not raised venture funds before raise funds. So what do they pitch? Do their pitches focus on spaces or theses? Or otherwies? If so, how does what they pitch to an LP manifest itself and play out in the investments they make. Sure track record is a piece of it, but is there any more depth to it than that? Beyond the people involved, are there other reasons why an LP wouldn’t just try to put their money in Sequoia and Kleiner or wait for an opportunity to do so? I raised an early stage round with relatively no real track record (as far as prior exits go) for my company recently, and I certainly would say that a piece of it was who we were. But a big piece of it was also the people game and the story we were telling. What’s the story that LP’s get told?And I would guess that there are more factors than just age that make the biggest difference. As Fred points out, there are about 15 different knobs they tune and adjust. Let’s say, Union Square, Accel, Benchmark and Sequoia all have slightly different fund structures. Beyond age, what else could change the dynamics of the conversation you have and more so, how do you go about discussing those with VCs one talks with.

        1. Scott

          Without any sort of investing track record, it’s gotta be tough to raise any sort of LP money. It’s probably necessary to have something to show for yourself, or some exclusive strategy that makes up for the lack of experience. Different alternative asset classes are also more attractive to LPs at one time or another – 1999/2000 was HUGE for VC, but 2005 was even more attractive for LBO.

    2. fredwilson

      Good questionsSome of which I think I can tackle in future posts on this topicThanksfred

  6. Scott

    great post – very educational!

  7. Frank Fisher

    This is a great analysis that clarifies a lot of details that aren’t often discussed in public.The risk of this type of investment is an element that is missing from the analysis. It would be helpful if you an expand on it.In particular, from the LP perspective, how is the risk-gain trade off of 2x over 10 years compares to a hedge fund, 5-star mutual fund, and mid-grade bond?

    1. Vijay Goel, M.D.

      Frank,Great point…allocation decisions should be based on risk/reward of next incremental dollar in the asset class, so I’d imagine risk/payoff curves could be pretty steep as the “blue chips” in each asset class fill and money is left for less established players and the LP gets to decide which players and how much.I’ve always wondered about the impact of leverage on funds– since the LP can leverage their own money, why have they allowed such an escalation of risk through leverage in hedge fund and PE investments? Does VC use similar financial tricks to “enhance” the LP’s return?

      1. fredwilson

        I don’t believe many VCs use leverage. Most partnership agreements prohibit it. The SBIC strcuture was leveraged VC investing but it has been scaled way back and is not a big part of the venture pitcure these days

  8. terra210

    This is an interesting series. Thanks very much for producing it. I would also be interested, (if you would be willing to share), what prompted you to start a fund? Is your educational background in business or finance? Or was it based on other experience? Since these types of funds are a vital part of our economy and production, it would be interesting to learn how they get started and who decides to start them.

    1. fredwilson

      I worked in the venture business for 10 years before starting a fund on myownI think that’s the minimum experience you’d want and I feel that the secondtime, when I had been in the business for 18 years, has worked out a lotbetter

  9. Ross Mayfield

    Great post as usual Fred. Would be interesting to explore how relationships with investments and LPs change when you are in the middle of a fund and things go horribly wrong or fabulously well.

  10. jedc

    This is a great post, Fred. Thank you for the insight, and I certainly look forward to reading more.

  11. Nick Molnar

    I’m wondering what happens when you have raised 2-3 rounds for a company but not yet hit the ‘revenue stage’. How do you decide to write it off or keep going? The “late loser” can throw off your model quite substantially, by the looks of things.

    1. fredwilson

      That’s a killer and you have to avoid it at all costs. If you can get others to help you fund the ‘late bloomer’ and keep your exposure down, then you can avoid killing the fund’s returns if it in fact is a late loser. But keeping it going all by yourself is a big no-no

  12. JoeDuck

    Fred thanks for sharing this great level of detail and insight. Super interesting and very much in the spirit of blogging transparency which makes life a lot more interesting for all of us.Two questions:* Hasn’t Union Square fared far better than the average fund over the past 5 years? That’s great, but I think we should be careful not to generalize too much about VC funding success from your example…* I’m not sure I follow how the net IRR calculation relates to time. Is that based on 6 years with a single payment to investors at the end of that period?

    1. fredwilson

      I don’t know that we have fared better than the average fund. It’s reallytoo early to tell. Ask me that question in 2014 and I’ll know for sure.IRRs work off of the cash flows. Take a look at the previous post (linked toin this post) for details on thatfred

      1. JoeDuck

        2014! But my new improved onliner attention span is only 14 minutes….Don Dodge had some IRR detail also – very impressive numbers if you continue to manage and pick companies so well.

  13. Humphrey Bogus

    In reality, the LPs do even worse–there’s no hurdle rate of return for most venture or private equity firms to earn their incentive fees. In other words, VCs pay themselves incentive fees on the first dollar of profit after the return of capital. The more LP-friendly way to structure it would be to pay incentive fees on top of the return LPs could have earned by putting the money into a risk-free note of equivalent duration.In other words, imagine an $80M fund returns $160M in 5 years. With no hurdle rate, LPs get their $80M back, and then the VC fund gets 20% of $80M = $16M. With a 4% hurdle rate, the VC fund would have to return (1.04)^5*$80M ~ $97M before earning their incentive fee–they only get 20% of ~$60M or $12M. The VC firm principals took home $4M (the difference between $16M and $12M in incentive fees for no hurdle and hurdle respectively) in this case simply for equaling what the LPs could have earned putting that money into a risk-free security.VC partners should only be paid for the value they create–that is, return above the threshold of the opportunity cost of capital. Plus, this analysis doesn’t take risk into account. If most VC firms were compared to similarly timed and similarly risky leveraged investments in the S&P 500, over time the leveraged investments in an equity index would trounce the vast majority of VC firms’ track record *before* costs, let alone after.

    1. Scott

      Don’t most funds have some sort of preferred return for the LP’s (i.e. 6 to 8 percent)?

  14. daryn

    This series is shining a great light onto a side of VC that I, for one, really know nothing about.It’s very interesting, thanks!

  15. Michael F. Martin

    Kudos to you for opening your business model up to the entrepreneurs this way.

  16. chris dixon

    What do you think of “cascading carry structures” where the carry % goes up (e.g. 25% or 30%) when the firm returns greater multiples (e.g. 3x or 4x) on invested capital? It seems strange that a $50M seed VC fund would have the same 20% carry as a $10B buyout fund, and it’s probably one reason successful firms seem to always raise bigger and bigger funds instead of staying at the size that suits them best.

    1. fredwilson

      Cascading carry makes sense to me but we’ve not adopted itHonestly, as some have pointed out, the risk/reward in VC is tough enoughthat when you hit it out of the park, the LPs should get to share the wealthratably

  17. Alex Hammer

    This and the preceding post are some of the most illuminating VC blog postings that I have ever encountered, providing great insight.I am not a VC so I do not know the evaluative mechanisms and standards utilized, but it seems to me that algorithms could be developed to predict investment ROI success. Using reverse engineering, one could look at the investment results of one’s (or others) investments, and then work backwards to determing what were the apparent charateritics and elements contributing to that result (and then test this algorithm against other results, seeing how well it fits and tweaking (or coming up with a new algorithm) for, for example, separate classes of investments.Areas that might be assessed/measured in such algorithms might include: historical and current rates of return in that sector, assessed exit avenues available and their payoffs, strength of team and operational capability, competitive analysis in regard to the percentage of value obtainable in market (or desirability for purchase or other exit) relative to competitors, etc.Not that it is pure science by any means. The art pieces include, among other considerations perhaps, notions of vision and disruption.Techmeme employs an algorithm (which people argue about) in terms of defining what are popular/influential tech stories that has made it in some sense, a go to informational predictive model. TechCrunch presents a framework (model), always evolving, that guides readers’ expectations (as well as tech entrepreneurs) in regard to how value will be measured.PREDICTIVE (AND THUS WITH INVESTMENT FINANCIAL) SUCCESS IS, IT SEEMS TO ME, HEAVILY TIED INTO THE ABILITY TO EXTRACT VALUE FROM NOISE. That is what the above models are attempts to do.

    1. Taylor Davidson

      The evaluative mechanisms used to evaluate VC investments are based on an understanding of the present and future. A startup typically creates or requires some fundamental change to succeed (change in technology, economics, marketplace, changing consumer behavior, changing management, etc.).Predicting the fundamental change necessary to extract the required value from the noise, in that scenario, simply requires too much “art” to make the “science” like that meaningful.It’s not hard to figure out the main things VCs look for in investments: tying those variables into a model requires too much judgment and assumption to make the results valuable.

      1. Alex Hammer

        I respectfully disagree. If major Wall Street firms can spend huge sums of resources on predictive models for financial modeling of incredibly complicated markets, why cannot VC’s do the same? Predictive modeling of a limited set of investments in such a fashion would be far simpler than what is done elsewhere (heck, even the leading baseball GM’s are employing advanced statistical models for ballplayer selection etc. to significant advantage)

        1. Alex Hammer

          Science is all about testing hypotheses to see how they correspond with reality, and continually making refinements such that our theories (in this case algorithims) result in greater predictive value (or at a minimum, perhaps, seek to maintain a degree of predictability (tread water) as markets evolve).

        2. iamverytall

          A couple comments below. Overall, I’m not exactly in disagreement – VC’s could certainly (and almost certainly do) do some modeling to help them figure out their potential ROI. However, I think that there are some considerations that should be taken into account.1. Predictive modeling is useful only up to a certain point. As I’m sure you’ve heard many, many times by now, the current credit crisis (as well as other crises, e.g. the LTCM implosion) can largely be attributed to blind, unwarranted faith in the power of predictive models. You could potentially argue that this was just because the models weren’t powerful enough – perhaps they failed to take into account what Soros calls the “reflexivity” of market behavior. But things like that are essentially black swans – you don’t know that they exist until your investment has gone belly up.2. What most major Wall Street firms are spending their money on is risk management, i.e. figuring out how much money they could possibly lose on a given investment, as opposed to what they are likely to gain. The models that tend to work best are the ones where there is a significant/huge amount of historical data to test against, e.g. corporate default data for corporate bonds. As the amount of data decreases, the reliability of the model begins to break down. This is why Moody’s had no real business rating CDOs and other recent structured products – there simply was no way that they had enough data to accurately model the risk on those instruments.There are a couple of points here. First, because risk models look at established structures, they should (theoretically, at least) have a fairly solid amount of quantifiable information about the underlying asset. Credit analysts can look at audited financial statements, etc. for use in their analysis of a company’s credit-worthiness. It’s not immediately clear that a VC can do the same, especially for early-stage companies that are unlikely to have detailed financials.Moreover, it strikes me that a lot of the “secret sauce” in venture capital investing is not in the quantifiable aspects of the investment, but rather in more qualitative views on macro-trends, management teams, the potential for disruptive change in established business sectors, etc. While it is not impossible to ascribe a value to these elements and place them in a model of some sort, the degree of accuracy that you’d expect to see is so low that you might as well just toss the whole thing out and pick your final number out of a hat. Garbage in, garbage out.3. It’s not necessarily clear that VC firms have the resources to do this sort of thing on their own. Major Wall Street firms are much, much larger than major venture capital firms.I’d say more, but this is getting really long for a comment. Again, I’m not saying it’s impossible. I’m just saying that it would be hard to build a model that you could rely on to accurately predict the ROI on a particular investment. You can (and probably should) put a handful of assumptions into a model that might give you a view on the likelihood of your investment’s success. But in my view, these models should always confirm hypotheses, rather than drive them.

        3. Preston Sumner

          And we’ve seen how Wall Street has used those predictive models to great effectiveness! I do like your point about baseball GMs – it suggests an inefficient market resistant to change. Since Billy Bean’s success there may not be much new advantage to be gained. Read Taleb’s “Fooled by Randomness” and “Black Swan” for some great insight into the pitballs of expert predictions.

  18. gtpsmits

    Hi Fred,Another very interesting post. I am struggling with one assumption on the above article, which perhaps you could clarify?You mention that if there are profits, the managers of the fund take a carried interest on the profits, in your case 20%. Do I understand it correctly that these monies go to the fund manager and not the partners of the VC fund? Are there any other dividend structures in place that look after the partner of the fund based on an investment?If so, and please correct me if I am wrong, that the total management fees would be in the range of: Total Management Fees: $20mm + Carried Interest Fees: $44mm = $64 mm (over a period of 10 years)?What I fail to understand however is why the carried interest fees should be deducted to get the NET multiple, the carried interest fee is only paid when the company runs a profit and should have no influence on the multiple, again please feel free to comment.All in all it looks to me that the fund managers are the ones with the best deal in the house: zero risk and, as in your example, a ‘return’ of 64mm compared to 222mm with 80mm risk for the partners.Kind regards,Pieter Smits

    1. fredwilson

      Your math is correctHowever, the fund managers do generally put up between 1% and 5% of thefund’s capital commitment so it’s not zero riskAnd the management fees go to cover expenses and not all of it ends up inthe fund managers pocketIn the case of small funds, very little goes into the fund managers pocketbecause there’s a certain amount of overhead that a venture fund must carryregardless of size (rent, legal, employees, financial management, etc)fred

    2. kenberger

      The “no-risk” factor for VC partners is a major point that’s widely misunderstood.When defending VC’s, Bill Gurley once told me “I can’t think of a group less worthy of your sympathy!”Despite this, here goes:It sure sounds like a good gig to get guaranteed the 2% per year regardless of performance. But partners all must put “skin in the game”, and the nuances boil down to the math. I know personally a VC partner who closed a $100m fund, and due to the nature of the closing and other factors, he actually had to *PAY* $400k out of his pocket first couple years just to start.

  19. kidmercury

    great data, thanks for sharing.

  20. bsaitz

    any comment on AOL’s reporting shutting down of Tacoda? i know you’re probably no longer invested in Tacoda, but what do you think of AOL’s direction there..

    1. fredwilson

      I read all the posts with interest and I think what happened is they merged the networks and are now using TACODA’s targetting engine on’s networkIf that’s the case, then it may be the right thing. I am not close enough to know for sure

  21. nerdavid

    Fred,Great posts. Have already forwarded on to several people, most articulate explanation I have seen of the economics of our business.Do want to point out, that even when on paper fund managers say they are in for 1-5% of the total committed capital, two factors mitigate the power of that commitment:1. If total management fees (net of costs of running fund) taken by that GP exceeds the actual commitment by 2-3X or more, than there is almost zero risk. E.g. if on a $200 million fund the GP commits 1%, meaning $2 million, but takes in $4 million a year in fees, after a few years that commitment is more than made up for, at least by 3X.2. Often the GP commitment is actually loaned to the GP by the fund…and then there is no risk.As you correctly point out, in small funds the GPs are completely in-line incentive wise with the rest of the LPs. As is the case in our $10 million fund…although there are days I wouldn’t mind collecting the management fees on a $200 million!;-)All the best,Jacob Ner-David

    1. fredwilson

      You are right on both counts which is why small funds like yours are often good bets if the managers are experienced managing funds of that size. Capital allocation and managing follow-ons is the hard part of a fund that is small

  22. dremoran

    Fred, wouldn’t the LPs get back 2.78x in this example? Don’t they get back $278m ($322m – $44m) on their initial $100m investment? Thanks.

  23. Jim Freidell

    Fred,The definition of venture capital success has changed radically in the past 10 years.Used to be (ca. 1980s-early’90s) that “winners” were defined as returning no less than a 10x money multiple, preferably in 5 years or less. That works out to a minimum 58% gross annual return.Looking at Thomson Reuters’ rather extensive (and expensive) VenturExpert database, your readers might be interested in knowing that vintage year 1995 VC funds (all funds started in 1995) statistically provided the following net returns to their LP investors:Mean Net IRR: 46% (≤44x Net Money Multiple*)Median Net IRR: 21% (≤6.7x Net Money Multiple*)So-Called “Pooled Average” Net IRR: 60% (≤110x Net Money Multiple*)(* Calculated as if all money were pulled down on day zero and returned on the last day of year 10.)As with your analysis, net refers here to returns to LP investors, net of management fees and carried interest.The 1995 vintage year funds are noteworthy because they “straddled” the bubble up and down cycle. Plus most all are fully closed out by now, so final results are in.LP investors tend to look at investing in the top quartile of VC fund performers. The top quartile of the 1995 vintage funds returned 65% Net IRR (≤150x Net Money Multiple*).Carrying this a step further, the top decile of these funds returned 129% net IRR (≤3,966x Net Money Multiple*).The moral of this analysis is that exceptionally few VCs provide most all the venture returns to their LP investors (and disproportionately enrich themselves and their portfolio entrepreneurs in the process). They all succeed by finding and fostering home runs and grand slams, not base hits. This can be proven historically by analyzing vintage year funds prior to 1995.Today, most VCs struggle finding and fostering technology “quick-flip” base hits that, on average, return 4-10x gross, mostly through M&A exit. Your “planned” 6.5x “winner” average clearly validates that.The National Venture Capital Association has published a series of now 3 studies illustrating that most historical home runs have not been in high-tech, but rather in low-tech to no-tech start-ups fostered into substantial sustaining corporations.Everybody’s knee jerk is to blame the pubic markets for the downturn in IPO exits.Yet, the fraction of M&A exits eclipsed IPO exits way back in 1997 – back when the IPO market was red hot, even for new issues built more on hype than substance (no profits in sight, let alone 4 trailing quarters).Thus, it appears that most VC firms and professionals are in effect still operating on 10-year-old bubble dynamics: Technology-based quick flips. Surviving VC firms will find a different space in which to focus – maybe by rushing back to the future.Investors serious in seeing a new home run opportunity can reach me at j.freidell at – Jim.

  24. Carl Wimmer

    Add to the “cut” that a VC gets, a further impediment to the VC model as being viable.The VC is one step removed, both from the technology and the investor. Imagine the power your real estate agent would have if you turned over your money and your decision to him in picking a personal house, or … doing the same with a car salesman to buy you a car….. how about picking a wife through a matchmaker – well … that is actually being done.Unless a VC can read tomorrow’s newspaper (and looking at the average VC portfolio, you know for certain that they can’t or don’t do just that) , in order to coerce a return, a VC is required by definition to make a deal that leans to destroying what an entrepreneur has created. When you promise 30% annual net returns, the only way you can attain it is by cutting from both ends – the success side and the entrepreneur side.Maybe the VC earns his fees after all by being willing to get his hands bloody

    1. Jim Freidell

      When you promise 30% annual net returns, the only way you can attain it is by cutting from both ends – the success side and the entrepreneur side.Not true Carl, at least not historically. The VCs of the 1980s and early 1990s helped immensely in creating 30%+ IRR wealth. Often, they individually had personal home-run experience: starting a company and taking such through IPO; creating a highly profitable free-standing and self-supporting billion-dollar corporation. Today’s breed of VC doesn’t generally have that experience. Instead most VCs at best have personally started a software or Internet startup and sold it before much in the way of net profits were ever produced. While that was the miracle of the bubble era, such strategy rarely succeeds today. Hence, VC profitability post-bubble is generally in the tank. Last year, Cambridge Associates opined that, of approximately 750 VC firms, at most 55 had a current fund that was not under water.There is a huge difference between building a self-sustaining multi-billion dollar home run from a start-up, compared to building an R&D or development division, masquerading as a start-up, effectively for a large suitor.Fred and other VCs may tell us that the current crop of entrepreneur is to blame. All want to create quick wealth exploiting their technical ideas, certainly not invest the time, money and effort to build real self-sustaining companies from their technical ideas. They may also tell us that their LPs impose constraints regarding what the VCs may invest in. Both may be true. But in the end, it is the VC that gets to pick its LPs and its portfolio companies. Their success or failure depends on their wisdom, experience, energy and commitment. So far this decade, the prognosis is not good (except with perhaps 10 or so VCs out of today’s 650 or so firms).

      1. fredwilson

        I would never blame the entrepreneurs. Without them, we’ve got nothing to invest in

  25. Eben Thurston

    These posts and comments are incredibly interesting and informative. I’m looking forward to the rest of the series and conversations. Thanks for pulling back the curtain, Fred.

  26. Steve_Sch

    Many funds now have what is called a recycling facility. This allows the GP to put back to use into companies any realisations it has up to the fees that have been taken out (in some cases even more!) so that all the money can be put to use into companies. In your above example, a GP can then use all $100 million to generate $300 million which after a 20% hurdle pays back $260 million, so 3x gross to get 2.6x net, which is somewhat easier than 4x gross to get 2.5x net. Of course, timing must work out that you have some early exits to recycle fees for later rounds…

    1. fredwilson

      We have a recycle provision in our fund but its limited to the amount of our management fees. The goal of it is to get the full amount of committed capital invested

  27. Scott

    Are management fees usually that frequent?I thought that for a fund’s life, 2-3% mgmt fee was for the life of the fund?

    1. fredwilson

      2-2.5% per year

    2. fredwilson

      That’s for the first 4-5 years during the ³investment period² then it stepsdown gradually to reflect less work and less companies under management

  28. Venu

    Whats the difference between a Fund Manager and Partners in a VC Fund.

    1. fredwilson

      Nothing usuallyThe fund manager might include a subset of the partners but usually its the same thing

  29. Venu

    How does a fund manager gets compensated ? is it in the same manner of 2&20 ? The carried interest comes only when an exit happens and that too its a profitable exit/ What if there is no profits in the exit or what if the exit takes more than the anticipated timeframe ? Till then how does the partners get compensated ?

    1. fredwilson

      Management fees are paid regardless of profits in the fund

  30. Vivek Aggarwal

    Can you please explain , how you got the value for average initial investment and average total investment

    1. fredwilson

      They are assumptions

  31. Ted Rogers

    This and the 1st post on Venture Fund Economics are my #3 All-Time VC posts. Once again, thanks Fred.

  32. Gabriele Grecchi

    Hi Fred,great post! I just noticed it’s a bit old, though :)I’m writing from Italy, where I’m trying to setup a multicompany corporate VC fund.I was wondering whether you could share the model (or the rationale) you created to setup Union Square Ventures. It would be very helpful to compare with mine and check my work.Thank you in advance for your kind help!All the best from sunny Milano.Gabriele