After yesterday’s post on Venture Firm Managing Partner Economics, I received a number of good comments and thoughts. Parker Conrad, founder/CEO of Zenefits, offered up that the economics for a VC change dramatically when managing multiple funds simultaneously. So true.
Here’s how the economics might look with multiple funds under management:
- Fund 1, with $100 million of capital, performs well (3x cash on cash), and Managing Partners make an average $2 million per year over seven years (most is back-loaded)
- Fund 2, with $150 million of capital, closes four years into Fund 1 (able to raise it quickly because of progress to date), performs well, and Managing Partners make roughly $3 million per year over seven years, but the first three years overlap with Fund 1, so during those years, the Managing Partners make $5 million per year
- Fund 3, with $200 million of capital, closes four years into Fund 2 (able to raise it quickly because of progress to date), performs well, and Managing Partners make roughly $4 million per year over seven years, but the first three years overlap with Fund 2, so during those years the Managing Partners make $7 million per year
Of course, this is all theoretical and is presented in a manner that makes the venture model look smooth and consistent (it isn’t). More complexities to the model include the fact that most venture firms don’t do well (see the Kaufman Report’s PDF – h/t @jalex2003), some have a hurdle rate before the VCs earn a piece of the profits (e.g. a hurdle rate of 8% requires the investors to get that return first – h/t @stephenfleming), and VCs have to invest their own money into the fund (e.g. invest 1-2% of the fund’s capital such that it takes several years of management fees just to get back to breakeven – h/t @lance). The venture business, and corresponding economics, are more complicated than expected.
What else? What are some more thoughts on the economics of the venture business?