VC Fund Economics
Charlie O’Donnell, who was our first analyst at USV and who now runs his own VC fund, wrote a post yesterday outlining the economics of running a venture capital fund.
Charlie’s fund, Brooklyn Bridge Ventures, operates on the 2.5/20 model. That is 2.5% in annual management fees and 20% of the profits after the investors get their capital back.
That is the exact same set of economics the USV operates on.
There are many, probably most, of our peers in the VC business who charge a “premium carry” of 25% or 30%, but at USV we have never moved away from 20%. If you do your job well, 20% will make you a bundle.
Back at Flatiron, we increased our carry on a new fund just before the Internet blew up and caused massive losses in our fund and every other VC fund. That was one of the many reasons Flatiron didn’t work out so well in the end. And that taught me a big lesson. When you raise your compensation, you had better earn your increase. We did not. No more raising carry for me.
I am not going to go line by line on the USV income statement like Charlie did. But we manage $1bn across six funds which is roughly $160mm per fund. That is on the small side for our peers and probably slightly below average for an early stage venture fund. One of our funds will stop paying management fees this year because it is ten years old. And we have a couple more that are paying reduced management fees because they are no longer in their “investment period”. And our two Opportunity Funds pay nominal management fees and are mostly about carry for us.
So while we manage about 200x what Charlie does, we don’t make 200x the management fees. We probably make 50x the management fees that Brooklyn Bridge Ventures makes. We have twelve employees and our own office. The people who work at USV are well compensated for sure, but our goal is to make way more on carry than we make on cash compensation. That is the basic point Charlie made in his post and it is true for us as well.
The goal of VC fund economics is to incent the partners to focus on carry and not on current cash compensation. That means that we are focused on generating large gains on our investments and that aligns us well with the entrepreneurs we back and the investors who provide us with capital. That works incredibly well in a small fund like Charlie’s, and it works pretty well in a traditional fund size like USV’s. It can break down as the dollars under management get larger and larger and the management fees turn into huge numbers. We have purposely kept USV small to avoid that. And I think that has been a good decision for us.
when did USV raise its first fund?
we raised it from the summer of 2003 to the end of 2004. took almost 18 months.
Did u start investing before you closed it?
Fundraising is a bitch for a first time fund.
Let’s keep the comments gender neutral, k?
Fundraising is really difficult for a first time fund.
Y’all doin it right now
is there a disqus app for that?
No. But there might be a browser plugin for that kinda thing.
that would be interesting. i’d like to see how that could work.
Kinda like this, but substitute “literally” and figuratively” for “his/hers” and “theirs” etc.http://www.npr.org/2014/04/…
bread and water
I loved Charlie’s “loan” analogy when describing the management fees.Do you think that 10 years is going to continue be the norm for fund cycles? Why not shorter cycles, like 5-7?
if anything they should be longer. we will not complete liquidating our 2004 fund for a long time. it could be 2020. i still manage some investments we made at Flatiron in 1999.
Is it ok to keep the fees at the same levels then or lower them in later years since your time requirement decreases, no?
that’s what you do2.5% for the first two years2% for the next two yearsdecrease by 0.25% every yearno fees after 10 years
The “loan” analogy is similar to the draw traders get at investment houses. Get a large enough draw to pay for your basic lifestyle and then make money on the upside. The draw gets subtracted out of the trading profits split with the house.
The link to Charlie’s post doesn’t go to Charlie’s post…good morning!
shiti will fix it
I liked the song it linked to! Discovery.
my song of the day http://fredwilson.vc/post/8…
I thought it was an easter egg, I enjoyed the song a lot. so happy to see merge records doing so well, their early releases were my soundtrack to high school (hometown label).
thanks Anne. that’s what happens when you are doing three things at the same time. i fixed it.
your avatar reminds me of the google ara phone design. is it a painting?
No, it’s a photo I found on Flickr under CC license, a stained glass window made by a Baltimore artist.
i really like it.
Thanks. I was looking for a visual metaphor for my work, and looking at photos of quilts and stained glass. This photo/artwork has a little bit of both.Have a great day!
Back a bit I had a loft on Broome street and took all the old windows, and built something similar as a room divider. Really like this and loved the way it worked in the loft as well.
I love that! My grandfather built a cabin in the early 40s and recycled old windows from a barn. They’re still there.
Ouch, sorry, I didn’t know the photo would appear when I posted the link. And I don’t think that I can delete it.
Hands down the most user unfriendly feature/bug of any connected service I use.Done complaining about it but it is still top of the top ten worst list. (@JimHirshfield:disqus )
You can remove the image by removing the URL.
Which funds charge way too much? And it’s that a sign that entrepreneurs should stay away from those VCs?
way too much carry?or way too much mgmt fees?
i think firms that manage fund complexes in the $5bn to $10bn range would be candidates for that
Because they’re just getting high off the fumes and have little motivation to make the fund perform, as I see it.
It’s because the companies in that portfolio are so established and the business models are generating steady profits so the fund managers don’t need to be active and shape/influence the direction.The secondaries piece of that $5bn to $10bn zone is more interesting if the manager wants to be active (e.g. do disposals, spin out the IP as a securitisation etc.).One of the roles my team did at the bank was create its Secondaries business.We didn’t do angel, seed or micro-fund end of the pipeline so I’ve learnt a lot about that from being a founder and being part of communities like AVC.
Angel, seed & micro isn’t simply an adjustment of scale for the fund economics to work.It’s also a different mindset and operational must-haves.The angel, seed & micro fund manager has to be as scrappy and McGyvery as the founders. They have to “put in the work on a par” (network on startup’s behalf, source talent, shape operational plans etc).Portfolios in excess of $1 billion already have most of the reporting requirements and operational frameworks in place, so the fund manager hasn’t as much to do except monitoring the portfolio constituent and that data is readily available because usually the constituent is typically publicly-listed.The angel end has different information sources (as we’ve experienced helping Fred and William compile their respective tables of startup investments).The lowest investment level I dealt with prior to being a founder was $3-5 million
That is $3-5 million per investment.So now there are incubators offering €40-50,000 for 8-10% equity and a raft of co-funding platforms like Kickstarter where complete strangers can pitch in $10 to get a project up and running.Still, it’s never the capital per se that counts.It’s the wisdom and knowhow that the investment brings.
As this thread is highlighting, most people think VCs/investors are “banking coin” and most would probably want to be a VC/investor because of that.I started as a teen in a big chemco and then dived into two data startups after I graduated (a hedge fund one and a content one). That startup experience was what got me recruited into the bank.My first tech project was sponsored by UBS’s Global Head of eCommerce. I created e-Intelligence.Then I got more involved with tech investments.Now I’ve transitioned back out into startups; this time building my own.For all the “VCs/investors are banking coin” in the world, I know the economics are different from that.The economics can’t account for the value of the feelings, learning and personal development that founders experience when we build something from nothing.And founders are actually the biggest investors of all.
and have little motivation to make the fund performWhat you are saying is that they get fat an lazy off the fees and that might impact their motivation to perform.But by my theory of the “big swinging dick”  it’s entirely possible and likely that they also want to hit home runs as well. In fact, by Fred’s point about “When you raise your compensation, you had better earn your increase.” that seems a definite possibility.Let’s say you were given a contract for 3 years to perform on late night television earning a really good salary to do so. In what way would the amount of money earned make you decide to tell less funny jokes and be a success? Only way that that would happen is if you were funny as a result of the hardship of having a hard life (like with musicians and other artists). My guess is that you would still work your ass off to create the best show possible. You are pissing in the weeds with the big dogs so to speak.
“… best show possible.” ALWAYS
My daughters roommate and childhood friend (both just graduated and are moving to Chelsea) is going to be an NBC page and working SNL. How cool is that. Apparently it’s the “management training program” at NBC.
You guys are bankin coin
Y’all tryin’ make some trouble ’round here?
I disagree. VCs only bank coin when they have successful exits. Some might think the management fee is a good buck, but you have to remember it is subtracted from exits-and no one gets rich off mgmt fees. Even if you were to make 400k per year off the fee, by the time you pay taxes and expenses, you aren’t rich. If you don’t have an exit, you aren’t raising another fund. That means a nice income for 5 yrs and then you are looking for a job-and still stuck with the responsibility of the companies in the fund.
I was talking to USV and Charlie
Fred said USV makes roughly 50x the mgt. fees of Charlie’s Brooklyn Bridge Ventures, even though USV manages 200x more in investments. Charlie draws $200k in annual fees which means USV is drawing approx $10M, spread across one office, 12 employees and prob fair market overhead. Yeah, I’d say that’s a sweet amount of coin, although obv exits is where the serious bucks lie.Curious what kind of car Fred drives these days?
Curious what kind of car Fred drives these days?I’ve concluded that because Fred grew up in a military family and has spent so much time (he has said) moving around that he never really experienced that love of cars that some of us of roughly the same age had dropped into our heads as we were going through puberty. Not to mention that he lives in Manhattan and quite frankly that’s not the place that you want to go driving around anything nice. If I need to drive into Manhattan I would rent a car not drive my own car almost certainly.I grew up in a place and an era where I remember people leaving on the window sticker when they got a new car  (my dad did that) and neighbors showing off their expensive cars and being in high school and drooling over some guy who’s father had a really nice car. I had my license a few days after my 16th birthday. It’s definitely not the same today. You are imprinted by your environment. My dad would get excited about cars (but not sports) and I picked up that excitement and it’s still with me to this day. I’ve never bought a used car.
Cars are hardly a badge of status in NYC like they are in LA, for example. That said, I’m quite sure a successful VC isn’t driving a “clunker,” military or no military background. I finally got rid of my car last year. I didn’t use it that often and got tired of paying ridic garage fees (anywhere from $250-$650 a month). A car is a necessity in NYC if you have a beach house or house in the country (which I don’t), while I’m quite content w/ the subway and bike, my primary modes of transport these days.
.Daughter in NYC, no car — rents one very economically when she needs one. NYC is organized well to be able to do this.JLM.
If I may ask where does she live and what rent is she paying? (My daughter yesterday rented a place with a friend and they made the other parent submit 3 years tax returns and they are both quite high earning I found it kind of funny actually).
.Chelsea, $3200 2BR, one year tax returns, guaranty. First, last, one month security deposit. Completely inflexible.JLM
My daughter just signed up for a 1br in Chelsea (they put up a wall or something) and is paying +-$3800 for that. Is this a doorman building? (So two people in a 1 br in other words).The other parent did the legwork and fell for all the hook lines and sinkers that the real estate people throw out. My wife (who has lived in the city) thought they were overpaying.They obviously exploit the fact that parents have a limited time in the city to help their kids and know that they will make quick decisions w/o having the time (or energy) to explore all alternatives.I was thinking that if I had to go and do this with her I would have paid a local $250 to $350 to get me up to speed and show me where to look to save me from having to spend time figuring it out from scratch. I don’t mean a realtor I mean a student that wants to make some cash for the day helping an out of towner navigate things. Could be a business opportunity here for someone.
There are no deals. There is nothing except what the market will bear which is a lot.Pick where you want to live. Pay what you can afford and enjoy it.
Assuming multiple players in the market (there are) and information not easily passed between players there has to be some arbitrage or discrepancy between the highest and lowest price for the apartment product that fits a particular need.Anytime I’ve had the time to thoroughly research the market I’ve found that there are things that are priced more attractively compared to other options.Also my comment is not strictly related to “deals”. It’s more someone who knows or has a better idea of the options and can fit something to that persons needs.Not everyone has the same set of requirements. When I was younger I bought a place with a dock because boating was important to me. To other people walking to the beach was more important. Perhaps the place with a boat dock was better for me at a lower price than walk to beach. Perhaps a place with 6 wine stores is better for you than to me.So the “$250 to $350 to get me up to speed” is to “save me from having to spend time figuring it out from scratch”.That said there is no question in my mind that brokers and management companies are able to exploit renters of the type I am referring to. (Need to make a fast decision.) Because this is what they do every day. And they are good at it.But this is entirely separate from the fact that there is high demand for real estate in NYC which of course there is. All I’m saying is that the game makes people overpay.
That’s a pretty sweet deal for a 2BR by Manhattan standards.
Amazingly organized on all things transportation wise.
Curious if you think there would be a market in Manhattan for the following:a) Car is stored offsite out of the city on a lot in non desirable real estate.b) When you need the car they bring it into the city for you.c) Option for both outdoor and indoor storage.Obviously it depends on how often you need the car and what your monthly cost is (and insurance differential seems like suburban insurance would be less expensive than in the city).I would think someone is doing a variation of this already. A car is a necessity in NYC if you have a beach house or house in the countryIsn’t it common to simply rent a car for the weekend for that?
I think your idea for an offsite parking garage that offers valet service is interesting but perhaps impractical for a few top-of-mind reasons:1) Manhattan congestion could make it really hard to accurately coordinate either a drop-off or a pick-up. You could ask for a 4p delivery and your car could very easily show up an hour later (or more).2) Double parking outside a NYC residence without bearing the wrath of NYC traffic/parking enforcement would be a challenge. If the garage delivers your car early there’s no real place to put. Further, if you get a ticket does the obligation lie w/ the car’s owner or the garage?3) It would be hard for a garage to manage manpower/staffing since consumer demand is difficult to predict. Sure, Friday’s will be busy, but midweek demand likely would fluctuate. How does a garage adequately and efficiently staff the service?4) After a drop-off how does the driver return to the garage’s “home base”? You could have a second car accompany the drop off, or you could have the driver take mass transit back to the point of origin. Either way is impractical.Enterprise offers pick-up and drop-off service and many other rental companies now do the same, although that type of service varies by market.Zip Car is the perfect urban solution…reasonably priced, convenient and efficient.
Manhattan congestion could make it really hard to accurately coordinate either a drop-off or a pick-up. You could ask for a 4p deliveryIdea would be to only offer early morning or end of day in order to coordinate and have drivers that actually needed to be in the city (for their jobs) and would use this in tandem to get in or out of the city themselves. Secret sauce so to speak. Scenario would be to have arrangements with parking perhaps (for short term buffering). If it was easy to figure this out there would be no opportunity.RE: #2 (see above)RE: #3 (see above)RE: #4 (see above).All good questions of course. But the point is to utilize some existing labor that would be taking public transportation and wanted to ear a few $$ shuttling a car instead.(There are also issues with tolls, insurance, etc. but like I said if it was easy there wouldn’t be opportunity).Enterprise offers pick-up and drop-off serviceYes but you are responsible to get their employee back to their office.I haven’t napkin’d the math but at the $500 per month end seems like there might be something that could work. Perhaps even the ability to allow someone else to use your car as well. For example if the car is located out of the city and you can take a train and get it at the lot and the price is right perhaps people would rent it (just thought of this on the spot in addition to the original idea which was on the spot as well).
Many merchants, both in and out of NYC, allow staff to drive company vehicles home to avoid paying garage fees. Benefits both the employee and the company.”Only early morning or end of day” is when coordinating a valet type service is likely most problematic. Rush hour congestion is horrific (like in most cities). For example, if you leave Manhattan and are heading to NJ, West, CT. or Long Island weekday after 3p you’re toast. The bridges/tunnels begin to clog that early.Other issues: increased gas usage, car depreciation, insurance coverage.I can see where your idea could benefit some but not sure how broad the appeal would be, part in light of the growing share car mkt.
When I dated a girl in NYC for a few years I managed to figure out the best times to get in and out without any issues. Typically very early or very late. I used to monitor 1010wins and adjust my route in the fly. Had a good system in place. I would even leave her place (on the east side) drive to the west side and in 10 minutes would know if I was going tunnel or bridge.So in a city such as Manhattan  it is entirely possible that there are people who leave for work at 3am or 4am and avoid the large chunk of congestion that you are referring to. Or depart at end of day way late to not have significant issues. Besides the idea is they need to get into the city. So even if they getup early 1 hour and get paid for doing so (rather than train) so they do it. Some people might even get a buzz out of driving a nice car (I did as a kid when the boss let me take his big car I would have done it for free).Gas usage is a non issue people just eat that and don’t think about it. (It’s not factored in as much as you’d think it is). Tolls of course would add to costs. Risk? Of course. But plenty of oppty to create a barrier to the other guy who wants to do the same thing.Pricing wise my guess is that it would operate at breakeven for the car storage (which on a cheap lot that is nowhere would be low) and then charge per entry exit which you share with the driver. Plus the parking for the car until the owner gets it. Something like that.Entirely likely that someone could have a car that sits for 3 weeks and isn’t used or 6 weeks. But they want to know that when they need to go to Vermont they will have their car. My point being in NY Metro there are millions and millions of people that go into the city at all times. And you only need to tap a small slice in order to “solve for x”.I am not advocating that after the napkin ink is dry the idea would work. However there may be a way to make it work. It’s easy to find why something won’t work (I am good at that as well).Look, I would never airbnb my place no way no how. But plenty of people will do that (much to my amazement).
Here’s an alternative to your biz idea:If one uses a car daily or even weekly in Manhattan, then car ownership and monthly garage rental makes sense. There’s a strong price/value relationship. Conversely, if one only has an infrequent or occasional need for a car, then a share service like Zip Car is a practical, efficient and convenient solution. Those two scenarios address both high and low market demand. I believe there’s a fairly large in-between market: Wwhere Zip Car’s hourly/daily rates aren’t cost-effective cause an individual’s weekly/monthly use is just too high, but but not high enough to justify full car ownership and a monthly garage fee. I think a large parking garage service, like ICON, should get into the subscription/share biz where they lease, service, insure and garage vehicles and amortize their investment by selling subscriptions to the service. For example, for $250 month a subscriber gets a minimum of x weekly hours and a 1 full weekend use per month. First come, first served. If you don’t use your allotment, then it doesn’t accrue.
Look all of what you are saying is all well and good. (And I agree in part).But what you aren’t seeing is that many times people make decisions that aren’t based on monetary reasons but rather emotional or intrinsic reasons.A few examples:a) A person buys a vacation place in Florida and only uses it a few weeks a year. Rationalizes it by both thinking the price will go up (not guaranteed) but also likes to think “they own a place”. And tell people that they do. Would be cheaper to pay for a nice hotel.b) A person buys a SUV (with AWD or 4WD) even though the amount of time you actually use that is quite slim. Likes to think that “it’s there when I need it”.c) People don’t like driving someone else’s vehicle. They like being an owner.d) People buy new cars when if you ran the numbers it typically says it makes more sense to buy used (where someone else takes the depreciation hit). You know what? I want a new car. I buy new cars. Goes beyond money.e) People don’t lease a car. They like to feel they can “get out whenever they want” and “aren’t locked in”.f) I have a friend who is paying $100k for a Hampton rental. I wouldn’t. I’d rather take a bunch of vacations. But I’m not him. He likes to be there and it makes him happy (I’m guessing).My point being $$ is only one factor.And so on.So once again all your points are valid but you are not looking at the “pride of ownership” (and yes that does exist even with cars).
No disagreement, that’s why I owned and garaged a vehicle in Manhattan for literally 10 years. Convenience certainly was #1 reason, but “pride of ownership” was a secondary or more likely a tertiary reason, too. But as the cost of living increases and needs shift one naturally reassess the price/value of h/her investments. Owning/maintaining a car in many cities is nothing like NYC. The cost in many cities is negligible…here it isn’t. Here one can (conservatively) lease a car for $350 a month, rent garage space for $400 a month and pay $150 a month in car insurance. I’m sure many people reading this thread spend on a single vehicle half that amount. Car share works best in large urban areas cause it addresses all the fundamental needs (e.g., low cost, convenience, reliability). Emotion def comes into play w/ car ownership, as the auto industry is one of the (if not the) most image driven industries out there. However, in select urban markets where the cost of owning/maintaining a vehicle is excessive, economics broadly trump both emotion and image.
Very true. At a certain point something that previously felt positive and good makes you feel, for lack of a better way of putting it, like a schmuck. I guess.I had a boat that I never used and it was costing perhaps $3500 per summer season (iirc) to dock it, service it, put it in and out of the water or something like that. But I was never able to use it so at a certain point I sold it just so I wouldn’t feel bad about not using it.I have a small summer place for a long long time but never really used it the past 5 years. So I finally rented it out for the first time. I don’t get much money but I don’t feel as bad for not using it now! (In fact it was a real pain to rent had to move things out and all of that).I pay nothing for garage space but pay more than $150 per month for insurance.
ZipCar rocks.I use it weekly. Audi for $16 hour, Mercedez for $17.50. VW for $11.99.
In NYC, it is fine to be a 20 something who can’t drive (uhhh, like me 🙂 )
You’re not really missing much. Cars in Manhattan are overrated…Nothing beats a 30 day Metro card 🙂
That was such a shock to my son that he has classmates at Hofstra who as native New Yorkers don’t drive. Do you think you will learn?
I don’t use Citibike.First, the bikes are very heavy and drive like Mack trucks. They’re, of course, designed and built to last. Second, there’s no bike share stations currently above 59th street, so it’s a bit impractical for me as I live on the upper west side. Third, I haven’t seen any statistics yet but I bet the emergency rooms are full of accident victims. Helmets aren’t required and tourists (frequent users) are more engaged with the city’s environs than perhaps safety.All that aside, many, many people in NYC swear by Citibike (as they do in other cities w/ similar bike share programs). I don’t think I’ll ever be a convert as I like the feel/speed of my road bike.
Sidecar isn’t avail in NYC yet but here’s an interesting personal experience I’ve had w/ the service. When I was in Seattle a few months ago I wanted to give Sidecar a try. So I Googled “Sidecar Promo Codes” to see if they had any introductory offers. I was immediately directed to a site for Lyft, a competitor of Sidecar’s, where I could get a $10 or $15 introductory credit by entering the promo code “SIDECAR.”Both brilliant and sleazy marketing.
Google encourages competitors to buy each others names as keywords and there was even a lawsuit about this. I suppose in theory it sounds sleazy but you know what at the end of the day if I search for something I think I do want Google to show me competitive products so I can make a fully informed choice. If companies want to fight it out by giving promo codes, etc. then that’s a win for consumers.
It’s a trademark violation. I’m sure the word Sidecar is protected in this context as is Lyft, Uber, etc. Coke couldn’t use “Pepsi” as a promo code either, and vice-versa.
Even if you were to make 400k per year off the fee, by the time you pay taxes and expenses, you aren’t rich.But more importantly since you are comparing yourself to your peers in the business (and in fact comparing yourself to those peers who you know about since that’s who you hear about you don’t read much about the ones that don’t make it) you will feel quite unhappy. Because the game you are in says you are nobody if you are only banking those fees.This is kind of loosely related to why if your father is a full professor at Harvard it’s probably not a good idea to go into academics. Since you will judge your success by what he has accomplished. Otoh if you choose a different profession, say you become a small company owner making $1,000,000 per year, you can feel very satisfied because you’ve changed the frame of reference for your career and think you are doing quite well in the circles that you move in and that you read and know about
400k in NYC is a lot different than 400K in Chicago, or Texas, or Iowa. Probably even Philly. Probably not a lot different in SF or LA.
Depends if you mean Philly metro or Philly city.Actually either way 400k in Philly gets you plenty for the money housing and lifestyle wise. A 1.2 million house in the Philly suburbs is quite nice and comes with a nice school. Actually 750k will do the trick for that matter.But as the saying goes “Sophia Loren without a nose is not Sophia Loren”.
Although trying to get people to relocate to the North Shore in Chicago was pretty comparable to getting people to relo to Los Angeles in terms of the income needed to maintain a comparable lifestyle.
Just keep in mind $400k x 5 years is more than most people earn in a lifetime.Agree that to make the business work, you need to generate returns
respectfully, you couldn’t be more mistaken. most VCs get rich off management fees. 20% of committed capital! regardless of whether exits produce meaningful returns, or even any returns.
American English or your own ism?
Banking Bitcoin I hope
Hedge Fund guys that have more than 2 and 20 start to ,move towards S&P returns. Do VC fund do the same and lose mo?
.An interesting post and instructive. The only thing I caught that was new was 2.5%. It’s a very good algorithm. A very safe algorithm.”Big” real estate is a bit different but similar.Big real estate is all deal driven. You build a $100MM building, you use OPM for equity and debt. Typical deal in the day was 10% equity and 90% debt, so very highly leveraged. Today equity is more like 30% or even more. Not as highly leveraged.The partnership was always deal by deal but standard from deal to deal.Equity investor gets 10% cumulative preferred return ON capital and preferred return OF capital, effectively a 1 x preference plus 50% of profits.Developer gets a development fee (one time) of approximately 3% which is funded by project and 50% of profits.Developer gets lease commissions equal typically to 2% of lease area x lease rate x lease term — 2% of net (no expenses). Outside broker collects a similar commission. Both funded by project.Developer also manages (property management) project after completion for 4% of gross revenue which is funded by the project and is a cost passed along to tenants in NNN leases. If one had a big portfolio, this could be a big number and a big business.Developer pays all corporate expenses and typically had a line of credit which was drawn and repaid as cash appeared. It took about $2MM LOC to manage $1B in assets/projects.If project saw 10% ROI and had cost of debt of say 5%, then leveraged ROE was 25%. Very healthy numbers. In rehabs, big rehabs like 15-story building or suburban office complexes, ROI could be as high as 15-20% and ROE was off the chart.The big thing about real estate is you’re paying down the debt so the value is being created both by rent increases and debt repayment thus creating value from at least two directions if not three: inflation, market appreciation, debt repayment.You go to the pay window ten years hence and you are reaping doubling + of rents, bit of inflation protection and repayment of a meaningful amount of debt. Value is set by “cap rate” – market number valued stable cash flow as an inverse multiple of cash flow.Market ROI now say equals 15% on $100,000,000 investment – fairly small improvement over 10 years. So you are bringing in $15MM annually.Market cap rate is say 7.5%.Building is now worth $200,000.000.Debt is likely $75,000,000.Gross “profit” is $125,000,000 on original $100,000,000.Investor is current on cumulative preferred return ON capital. Investor gets 50% of $125,000,000. Developer gets 50% of $125,000,000.In the old days, developer (active partner) gets interest, depreciation deduction during life of project but has to pay “recapture” at cap gains rates when project is sold.If a developer does 2-5 projects each year and they take 2-3 years each to get right and then holds for 10-15 years the business is a very good business.There are very few “misses” if you hold for 10-15 years. I have literally never seen a miss with a 20 year holding period. This is why real estate is so safe as an investment class — well except for Kiev real estate.Of course, the developer is running a business directly and location, design, construction, marketing, finance, property management are core skills. It is an operating company not an investment. Many developers are so good at one or the other they can whip the market’s butt on that particular score.Real estate at this level is still a very lucrative business. This is why the best REITs can be very good investments over a long period of time if they are developers and not just investors.JLM.
Have data on private equity funds?
.I know the deal structures as I have contemplated starting one but I am not an expert. On the real estate, I invented some of that stuff so I am very comfortable sharing it and knowing it is accurate.JLM.
In my mind, it’s the ability to understand and influence (emphasis on the influence) the economics of a business that separates a true businessperson from a W2 employee. I’m a small time real estate investor, and consider the above Real Estate 101 (and perhaps 201, 301, and 401 as well). Copy and pasted to my game plan.Well played, JLM
ditto – just made myself a note where I usually place code snippetshttps://gist.github.com/vic…
have you ever created a reit?
.I came w/in a cat’s meow but sold the assets before I completed it. I did all the legal work.JLM.
The focus here seems to be on creating value, and this requires a long-term perspective. Earning from the true value created by you investments as opposed to skimming earnings despite performance. That seems very wise.
Do the other employees (non-partners) see any of that success beyond their salary?
All is well in times like this where profits are abundant and investors are gleeful, but reality is a bit different when the economic climate is harsher and the wastefulness of investments in nonsensical ideas comes home to roost. At that time these fees are a pretty penny.
Bond market is riiiiggghhhtttt over there —->>>>>
There are many, probably most, of our peers in the VC business who charge a “premium carry” of 25% or 30%, but at USV we have never moved away from 20%. If you do your job well, 20% will make you a bundle.When you raise your compensation, you had better earn your increase. We did not. No more raising carry for me.Look, you have to do with whatever feels comfortable for you.But from what I know as far as VC’s “hitting it out of the park” or “not”, it’s hard to believe that charging a higher fee is going to translate into more investor love in your particular situation given a good outcome.People tend to forget the price and remember the service and end result of what they paid for.You will either choose the right company or you won’t. The market will either be right or it won’t. Luck factor, timing, your instincts and everything else involved.If you don’t choose correctly people will think any fee is to much. And not be happy. And if you do pick the winners they will be happy and as a general rule forget the price that they paid. Especially if your pricing is in line with other VC’s.Here’s the thing: It’s entirely possible that you pickup up investor funds easier by delivering and charging a lower fee. Or you think you do (your mind vs. reality). So in that case it’s a good marketing angle if it works (and I guess I would have to know more specifics).Back at Flatiron, we increased our carry on a new fund just before the Internet blew up and caused massive losses in our fund and every other VC fund. That was one of the many reasons Flatiron didn’t work out so well in the end. What am I misreading here? Raising fees didn’t cause the landscape to change. The internet would have blown up anyway so why link the two events?My ddx: Maybe, because of what happened in the past, just like a sports player, you have your lucky bat or some action that you feel is linked to or could trigger bad luck. And that is why you don’t want to raise the vig. Personally from what you wrote above that seems possible. Which is fine.  I have a habit of never ever discussing deals with anyone until the money is in the bank and I do mean the money is in the bank. It’s just what I’ve always done and it’s worked for me to not get anyone’s opinion so as not to disturb my instinctive thought process. So it’s taken on a life of it’s own almost like a business “tick” that I can’t disturb no matter what. Just like the lucky bat.
One way to reduce the incentive to grow is to use a budget model for fees, of course. I’m a little surprised more firms don’t do this.
I have seen more tiered carry, like 20% after contribution and then 25% after 3x. But I haven’t seen tiered fees like many hedge funds, going down with bigger AUM. For example, 2% of fee on first $200mn and 1.5% after.
.As a general observation, I have looked at a lot of VC funds as an investor and I do not ever recall seeing one that had the management fee decline over time. Normally the proceeds of liquidations take care of that as the “funds under mgt” is a declining number.JLM.
Hi JLM. I have invested in numerous VC funds in last 20 years and literally every single ones steps down. Usually after year 5 (after the “investment years”). Then they reduce by 10-15%/year. Most do 12.5% reduction/year. So 2% becomes, say, 1.75%, then 1.53% etc. As pointed out above, averages out to 2% committed capital/year, or 20% of committed capital. Some funds return fees before carry, some don’t. One enjoyable argument I’ve had with Fred and my other friends in VC is over the fact that almost no VCs publish operating budgets for LPs to review – so LPs can calculate management fees if they want, but can never ever ever know where those management fees are being spent. How much on rent? How much on GP salaries? How much on god knows what…. 🙂
the hedge fund renaissance technologies charges an astounding 5 and 44. they manage 17 bln i think. if you check out the returns they are still outperfoming most everyone; they are the lebron james of asset management. they have a huge staff of math and physics people — preferably no financial background, as everything they do is about making the connection between quantum physics (i.e. you never know where a particle is but can get a probabilistic model of where it might go) and stock prices. as private markets become more like public markets, i think these types of quant funds will emerge in the VC space too. see fred’s post o moneyball for VCs back in the day.i am a huge fanboy of renaissance technologies.
> making the connection between quantum physicsYou are saying that Schrödinger’s equation plays a role?Once I was in an NSF summer math program. There was a geometry theme, and one of the other students was an ugrad at Harvard and had a reading course with A. Gleason. I got a copy of the notes of S. S. Chern and still have them.Hmm, I was in line for the Chern-Simons result!But, but, but, Simons is ‘just a mathematician’ who started with no background in finance. And, does he even have an MBA? What about ‘business development, marketing, sales’? Surely those are really important also? I mean, 1 + 2 = 3, and everyone knows that and what more could there be, Besides, computers are now the best at math, right? :-)!
There is a lot of confusion on the role that math plays in the performance of Hedge Funds. The connection to quantum physics (geometric brownian motion/ markov processes) is not how Hedge Fund money is made. While math does play a huge rule in some of the analytical solutions to the partial differential equations used to price derivatives of stocks and other assets, for most hedge funds multivariate econometrics and speed are tools of choice, something far removed from quantum physics.
sure…..the mathematical principles are the same, which is why they (renaissance) hire math/physics people only — not econ/finance/value people.
I am not sure how math and physics can over ride earnings and profitability . It is true excessive risk taking can generate high returns in a year or two, but this method can also wipe out good chunk of fund’s capital in a year or two. In essence investing will come down to profits and earnings. Technical charts, quantum physics, etc in the long run I doubt they make any difference.
You can see some of their historical returns here:http://www.marketfolly.com/…In 2008, they were up 80%. Not a single down year from 1993 to 2005.
because they model stock trades like they model water
“We probably make about 50x the managementfees that Brooklyn Bridge Ventures makes.” Aren’t you supposed totrack cash flows as a venture capitalist? Does a venture capitalist say, “we probably have about 3 to 12months of cash left in the bank.” Well, is it 3 months, or 12 months? That’s probably pretty important to know for a smaller company (BB), unless it is so much that you don’t need to track it exactly (USV?)? If Ihad to guess, I would say USV pulls in $12.5 million per year at a minimum, andprobably much more. Do these funds even have a step down clause – could becloser to $15 or $20? For 12 employees, that’s at least over a million to eachemployee, and considering seven of those are not partners, probably equates to a bit more per partner. I agree that carry is great for financial upside, but anyone living on $1million+ per year is doing OK. I preferred Charlie’s post because at least he had some newinformation that most people usually don’t see or think about. All the information in this post is public information, and most of it is found on the landing page of USV’s website.
Thanks for the transparency, Fred (and Charlie). I’m curious: of your institutional LPs, what % of their portfolios are dedicated to VC? How has that changed in the last ~20 years and where do you see that spread heading? Tangential question, but still related to the economics of the fund.
Thank you for sharing these Fred. We operate a similarly small fund from an exotic location called Greece. Here’s an attempt to broke down its economics from the perspective of the size of opportunities each VC is required to go after – http://gtziralis.com/primer…
I was having a discussion recently with a friend who started a hedge fund of moderate size. They follow the standard 2/20 model and we were discussing whether it would be a valuable competitive differentiator to reduce the management fee substantially? Granted you need enough to maintain the ongoing operations, but as you said, cash compensation isn’t the point or end goal. And in today’s day and age, funds can run much more lean than in the past.Granted the VC world is different than the hedge fund world, but when you hear stories of Ray Dalio taking home $600MM last year (from management fees primarily) when his fund returned 3.5% – 5% which was well below the S&P even in a reasonable year, it seems like there’s misalignment.
I am not quite happy with the 20% carry argument. I am an investor in the fund and a managing partner of a fund. As an investor I would actually prefer to give more carry to the fund. If it is 30% instead of 20%, the economics of the fund partners is improved by 50%. I think that in most cases the increased incentive will compensate the nominal decrease of investors return. On the other hand as a managing partner I would be happy to have 30% carry to split between all people involved in the fund!
Management fees +Carry creates wierd incentives by the sound of it
If you do not make carry happen, the fees disappear.
zombie funds with management are still around. Plenty around. Most venture funds don’t return, remember
I am curious the degree to which an established VC (like Fred) sees each new fund like a startup.
One thing Charlie wrote, and I have a question I hope the community here can help answer, is that he thinks $100K is probably less than most funded CEO’s make. I’m a CEO, of a startup, in the process of raising a medium seed/A round ($2.5-3M), and feel very fortunate about it. I also want to increase my pay to around $100K. Is this the normal time to do that? I’ve been operating for one year on $0 pay and ~1yr on $50k, in NYC, as a 30yr old.Is there a norm? Am I greedy? Am I being stingy with myself? Any opinions, comments, and advice would be much appreciated.
100k is low
What is typical (if there is such an amount)? This is one area where data would help… as the boss, I set my own salary. I want to be able to live, and maybe save a slight bit (in reality pay off debts from my $0 years), but feel like I need to still keep it low. Am I being to humble?I really haven’t seen much written about this anywhere, though I think it is a topic ripe for a writeup.
I usually see 120-150 in series A funded startups. I like keeping it low but not uncomfortable.
$100k is not a bad number to take your salary to after the A round, but over time, if you remain CEO, you should probably get paid a bit more
Small nit, but I’m pretty sure you guys are actually 2/20. you are 2.5 in the initial years, but because of the step down factor you describe in this post (which i remember), you effectively average out to 2/20 over the life of the fund, which is the old standard of the VC industry forever.
it averages a bit less than 2% per year over the life of the fund, but yes, you are correct
This is why, when I started my Fund #1, I took no fee / 20% carry. I felt that, over time, I had to earn the right to charge a fee.
what did the investors think?
Thanks for asking, Shana. For most, I think it was an extra sweetener to invest in Haystack #1. That said, some people who wanted to invest also encouraged me to take a budgeted fee or even charge a %. I will do so for Fund #2.
interesting that many people wanted you to take a fee
Not so many, but a few. To be honest, even for Fund #2, I’ve been concerned about taking a fee. I think I will (sorting out legal docs right now), but I do wrestle with it. For larger investors who make more concentrated bets and work closely with the companies, a fee makes good sense.
“That is 2.5% in annual management fees and 20% of the profits after the investors get their capital back.”Minor clarification – P&L vs Balance sheet…My sense is that the P&L split for between LPs and the GP is 80/20 from day one…..however the GPs can not share in Distributions until LPs get their capital back.
where is your post about the One May political campaign? I do not see it anywhere.also, have you thought about allowing for a ‘collapse’ function to concertina the titles of your posts together in a long list? it would make scrolling through a lot faster to find a back post.and also, in your archive there’s the ‘cloud’ index. different colors for different headings might help. the headings with the most regular posts perhaps ought to get some color.
This is big money. I can’t even start to comprehend this as a young entrepreneur. Thanks for sharing though.
hi fred. as always, grateful for these discussions and your unique commitment to openness. for me, though, i still think all one needs to know about the VC industry is that no VC (that I know of) provides LPs with fund operating budgets. That is, LPs can calculate what is being paid to GPs in management fees, but LPs have no idea where the management fees are being spent. The irony is delicious of course — no VC would ever invest in a company that doesnt provide the VC with annual ( or even more frequent) operating budgets. But VCs insist that their own investors simply fork over very large sums (20% of committed capital!) without having a clue as to how that is being spent — how much on rent? how much on GP salaries? how much on… god knows what….
I remember when he bought that car. He was at USV at the time
“doesn’t need to do that for deal flow, though I imagine it helps…” Your friends in marketing are nodding along vigorously. It certainly is the gold standard of marketing where I’m from. Giving back, paying it forward, educating your community …
You know there is this theory in business that a great sales guy to have is a guy who just got married and has a few kids on the way. Because you know he will be motivated to work hard and not slack off. Because he needs money.I have to tell you that when you drive around in a nice car you often get attention from guys who admire that car. And although I can’t scientifically prove this, I kind of get the feeling by chatting a few minutes with them, and even seeing how hyper that they are, that they are really trying to bust their ass because they think they need to achieve some material goal of success and that it will make them happy. And the pursuit of that goal really motivates them to work hard and try to take advantage of any and all opportunities.Charlie (the OP not you) has a nine year old car because he lives in Brooklyn, rides a bicycle, doesn’t care about cars and even if he did he realizes that a brand new car in Brooklyn would either get damaged or stolen. And so it would be a negative not ap positive. So I don’t see this as a founder or frugal mentality at all. Nor do I see it as necessary in any particular way to prove a point about where one’s head is at.
Yup, yup yup. Speaking of giving back, I had an hour convo with founder of Give Back Homes (http://givebackhomes.com/) yesterday – love absolutely everything they are doing to promote giving back in the real estate industry. Amazing work they are doing already.
Note sure what you mean by “If you knew him you’d likely feel the same way ( do you?) .”Separate question. I’m curious as far as living in NY Metro and how that factors in to his choice in a business sense. In other words is he in NY because it’s good for business or is he in NY because he wants to be in NY?Anecdotally I hear of many parents that live in NY because it’s where they want to live and it’s good for them. Not necessarily good for their children though.  (But yet they would swear they are great parents and do what is best for their children.) You know kids are happy swimming in the pool in Edison NJ Holiday Inn vs. some island it’s all the same to them.