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Venture Fund Economics: Gross and Net Returns

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A very informative posting from Fred Wilson of Union Square Ventures on his VC blog yesterday. If there are any would-be start-ups out there, or younger companies looking for venture capital, his post is essential reading. Here’s a snippet, but there is a load more info over at his site:

The returns venture firms get on their investments are called “gross returns”. 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.

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.

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.

So to make it really simple, a fund needs to get 4x on its investments to generate 2.5x in distributions to its limited partners.

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.

[From Venture Fund Economics: Gross and Net Returns]

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Monday, 4 August 2008 Posted by | Uncategorized | | Leave a comment