How do you assess VC fund fees?

A fascinating development in Web3 VC is the emergence of tokenized carried interest. Traditionally, carry is paid in cash. However, some Web3 funds are exploring paying a portion of carry via the fund's own token or tokens of their portcos. This aligns incentives further with LPs, as value of these tokens is directly tied to the success of the fund & its portfolio. Imagine a Web3 fund invests in a promising play-to-earn gaming project. Upon a successful exit, the fund might distribute a portion of its carry to LPs not just in cash, but also in the form of the gaming project's tokens. This allows LPs to benefit not just from financial gains of the exit, but also from the potential long-term value creation of the underlying project's token.

2% management fee should not be an issue for LPs compared to the risk they take with VC asset. For a GP, the fee is critical at first as (fund's size x mgmt fee) defines the annual fee available. If that number is small then it gets tricky for the GP since he/she will have less resources to begin with. As an LP, you definitely want GPs to do their best. So depending on the fund's size, a higher but diminishing rate is acceptable; i.e. for a $20mn fund with 8 year, 3% for the first 3 years (invest), 2% for the next 2 years (manage), and 1% (Exits) for the rest, on avg. 2%, increasing the success of the GP. Carry is a bonus and 20% is widely accepted. When comparing funds, look for more i.e. team, thesis, portfolio construction, hurdle, dist.

Love the 5 for 1 and done. Way better than the 2 per year for 10 years. Too many VCs eat too much fat on the raise! VCs supposed to make more money on the carried interest not on the management fees

Typically, there are three components to the VC fund. There is the management company at the top. There is the General Partner of the fund. And then there is the Fund itself, into which the Limited Partners invest. The General Partner probably also invests a small amount (1%). And the fund pays the fees to the General Partner, which in turn pays the fees to the Management Company.

There are 2 aspects typically missed regarding PE fund fees: how deep and active is the contribution of the GPs on the performance of portfolio companies and the the invested vs committed capital ratio. While the 2&20 rule is kind of standard, the marginal difference on comissions is neglectable, while the impact of a best-in-class team on high performance of portfolio companies and the % of invested capital,makes the difference for the LP. Sofitiscated capital structures on investings to deliver lazy xMoics on 70% of invested capital over committed can not be rewarded the same as a high performance teams actively involved in generating value on their portfolios on a high deal flow of opportunities with a differential value proposition.

VC fund fees are way more complex than most people think, Management Fees and Carry are just the tip of the iceberg. Management Fee: Usually ranging between 1% and 3% depending on size of the fund and its strategy. Fees differ between the investment and divestment period in % and reference value. Carried Interest: Ranging between 15% and 30%, either with or without a catch-up mechanism. Or in a tired structure. Organizational Expenses: One-off expenses, usually capped at 1% or a fixed amount of the committed capital. Other Partnership Expenses: uncapped annual expenses to run and operate the fund (e.g. audit, fund administration, ESG). Liability Fees: Charged to LPs on an annual basis (usually EUR 2.500) by the GP GmbH.

While it is common for larger funds to have a "standard fee" structure of 2/20 (2% yearly fee with 20% carry), emerging fund managers with smaller funds could do a top-heavy fee structure (3-4% annual fee for the first 3 years of deployment, 1-2% for 2 years follow-on deployment, and then 0% for the rest of the lifecycle of the fund. While risky, this works of emerging funds as most managers will go raise a Fund II with a similar fee structure about 3-4 years after Fund I, which will supplement the fees from Fund I as they lower to zero. This also allows them to manage the high operational costs as well paying themselves a livable wage. Others might defer their fees as their contribution to the fund instead of adding their own capital.

The management fee may vary with time. It might start higher (2.5%) during the early years when most of the deal sourcing and investing is being done. And it may decrease to a lower level in year 5 or 6 (1.75%), when the fund is less actively investing. The carried interest could be 20%, or 15% for a first-time fund, perhaps with a hurdle rate of 5-8%. The carried interest could be per deal (American waterfall) or per fund (European waterfall). In the former case, there is often a 25% escrow for claw back of carry in case too much was distributed to the GP.

Emerging fund managers often opt for a low fee / high carry structure to send LPs a signal about how committed they are to value creation (how “hungry” they are). Also, management fees on small funds (<$20 million) don’t pay much. These GPs tend to pay themselves very little or not at all, to maximize the money at work. They hope to hit gold on one investment, allowing them to raise a bigger fund afterward.

VC fee structures are the most rigid aspect in venture capital - mainly driven by what LPs know, understand and expect. Nonetheless, the fee composition and investment-to-fee-ratio is a very important determinant for potential success. A fantastic fund may deploy 100% or even more based on the committed capital (e.g. via recycling). A small fund with a high cost structure and no recycling may end up only investing 70% of the committed capital. In other words the fund with 100% needs a 2x MOIC to get to 2x TVPI, while the fund with 70% needs almost 3x MOIC to get to 2x TVPI. Same asset performance, with a 50% delta in TVPI performance.

Aside of management fee (excess management fees should be reinvested) carry has to be the one where LPs and GPs should be fully aligned. Tiered Carried Interest is for me the way to go. Bad performance should not be rewarded the same way as above average performance. E.g. 15% carry for below 2x and 30% for above 3x (or even higher). One of the biggest flaws in venture capital is the misalignment on management fees in bigger funds, as GPs live of management fees and not of their carry. So most GPs opt for bigger funds and a lower perforce trading insecurity (carry) for higher management fees. While having the same absolut carry with a lower performance, just due to increased fund size.

The market has long established famous 2&20 rule. And I believe it’s a proper balance and sanity check about motivation of the management team. I have seen a lot of funds focusing on AUM and management fee rather than exits. And that’s not the way to go. If you believe in your strategy and ability to deliver 20% of the carry is a fair deal. In my own case in my fund I have lower carry if the Cash on Cash is lower that 3x. That keeps me motivated to push for higher returns and assures LPs I’m not gonna stay on lower returns.

Work backwards from your expected rate of return, and do scenario testing to see what happens if you are in the bottom and top quartiles - if you are happy at the risk profile after fees then nothing to complain about. Also know who you are speaking to. Sequoia may have much higher carry but sit historically in higher quartiles than the market, whereas less known managers may go under market standards of 2/20 to attract investment.

Most of the fees you will see as a LP will be standard (1.5-2.5% management fee and 15-20% carry). You might be interested in investing in a first-time fund (a hungry manager with a smaller fund does tend to have alpha). In this case, you might see lower fees. Or you might be seeking an established track record. In this case, you might see higher fees, especially for historically successful management companies.

There is plenty of information on the 2/20 model and all its derivatives e.g. 3% front loaded fees that decline in later years which are commonly employed by managers with less track record. In the end, the differences are marginal, especially if the fund performs. As a fund LP, I would look at the fund hurdle rate (if one applies at all) since this can impact the returns waterfall. Understand GP plans to raise a follow-on fund. This can create liquidity via secondaries or impact MOIC since the subsequent fund can double down. Assess their chances of success. Empirically, fund attrition rate is 25% between funds (it's 2x higher for 1st time funds). Given the funding winter which I expect to last till end 2024, this isn't a given.

In reality, management fees matter little to the LP when the fund performs well. You will see that the difference is minute if modelled in excel. There are reasons in favor and against higher fees. For us, in our first fund it was important to have decent fees because we needed to build a team and pay them sufficiently. As funds grow the management fees grow and hence this could lead to misalignments with LPs. As an LP decide if you want to invest in the asset class, then choose the best manager/investor you can. Fees are secondary in VC, in my opinion they should be considered but it shouldn't have a lot of weight in the últimate decision to choose a GP or Fund.

GPs of the VC fund typically charge between 1.5-2% as management fees to cover their expenses. Their focus is largely making money out of carry which is generally 20% but may vary from 10-25% range depending upon the fund, its cycle and growth numbers. Other clauses like Waterfall, Catchup etc. as well affects the fund fee structure.

There’s three things to know: 1. The level of fees, 2. are they calculated on committed or invested capital, and 3. what is the schedule Then it’s a matter of assessing whether they are industry standard or not. Then if not, ask the GP why it’s not industry standard. Industry standard would be 2% per annum calculated on committed capital during the investment period and then switching to net invested for the remaining life of the fund. Note, there may be fees charged during extension so check the LPA.

Fees are typically standard, with small deviations. I would focus more on the overall potential return on the fund—it's sort of like taxes: I'd rather pay more taxes because I earn more money! Particular attention is paid to the experience of the partners (e.g., do they have operating experience?) and their own stake in the business (how much did they put from their pockets into the fund?). Those can be a few signals that might matter more than the fee structure of the fund.