Understanding the Venture Capital Fund Structure

Decoding the Roles, Responsibilities, and Fee Structures of Venture Capital Funds

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Limited Partners

• LPs invest in VC funds and evaluate potential investments based on the VC's asset allocation strategy, investment criteria, and investment process.

• The money for VC funds comes from various sources, including institutional investors, endowments, foundations, pension funds, insurance companies, banks, corporations, U/HNWI, family offices, fund of funds, and sovereign wealth funds.

General Partners

• GPs are responsible for managing the fund and connecting LP capital to the founders of startups. They also contribute to the fund and have a fiduciary responsibility to act in the best interest of the LP.

• A VC fund is governed by a limited partnership agreement (LPA) that lays out all the terms of managing the fund, including fees, expenses, and other details.

• Fees go to a management company, usually, an LLC, set up to operate the fund and cover salaries and other expenses.

2:20 and Carry

• Carried interest is the share of profits of the VC fund that goes to the GP and employees.

• Management fees are typically calculated as a percentage of the committed capital of the fund and are meant to cover GP/employee salaries, legal and accounting fees, office space, and additional costs.

• Management fees decline on a formulaic basis once the investment period ends when the fund has made all of its initial investments.

• The harvesting phase is the period when all investments are done, including follow-ons, and the VC is waiting to see which portfolio companies are growing and when they will exit, so the VC can harvest those proceeds back.

• The performance fee, also known as the incentive fee, is the profits above a certain benchmark.

• The typical fee structure for VC funds is 2 and 20, with 2% of the fund charged annually as a management fee and 20% of the profits (carry) generated split between the GP and employees.

VC Roles and Responsibilities

• Find:

  • Finding the best companies for investment, both inbound (when they reach out to the VC) and outbound (when the VC reaches out to them).

  • Leveraging the fund's access, brand, and reputation to attract the best entrepreneurs and startups.

• Decide:

  • Deciding which companies to invest in based on fit and valuation.

  • Evaluating whether the investment fits the firm's strategy and what the appropriate valuation for the company is.

• Win:

  • Winning the right to invest in the chosen company.

  • Proving to be a good partner for the investor since capital is becoming a commodity.

• Help:

  • Helping the company be successful post-investment by providing support, mentorship, and strategic advice.

  • Providing operational and financial resources to assist the company in achieving its goals.

• Exit:

  • Facilitating the company's acquisition or initial public offering (IPO).

  • Helping the company find a soft landing if the exit is not successful.

  • Providing expertise and resources to maximize the value of the company at the time of exit.

Roles

• Analysts:

  • Responsible for sourcing potential deals and helping partners, associates, and principals with whatever needs to get done.

  • Often assigned scut work such as due diligence and investment memos.

• Associates:

  • Responsible for honing their sourcing and refining skills to pre-qualify companies as they move through the pipeline.

  • Exposure to the board is rare and typically limited to lower-level companies within a portfolio.

  • Heavy focus on due diligence and investment memos.

• Principal/Vice President:

  • Can captain a deal from start to finish and knows the legalese around term sheets.

  • Influences the investment committee and contributes to the fund's investment decisions.

  • Promotion to partner often relies on their track record of capturing deals and helping portfolio companies.

• Partner:

  • Seasoned venture experience and/or a successful track record as an entrepreneur or operating executive.

  • Focused on fundraising, investment decisions, and board representation for portfolio companies.

• Other roles:

  • Platform team: responsible for providing post-investment support and services, such as talent development, business development, human resources, and operations.

  • Post-investment support is a big differentiator for VC funds, as investors cannot offer as much support to founders anymore.

  • Startups strongly evaluate post-investment support when choosing a VC.