Continuing with yesterday’s post on the insider view into the venture world, there’s another element of venture funds that I didn’t understand and that’s around cash flow. At first, it seems like if a venture fund is $50 million, then they have $50 million to put to work immediately. In reality, it’s much more complicated.
Here are a few nuances around cash flow in a venture fund:
- Capital is committed by investors and then called as needed (e.g. a limited partner makes a commitment of $1 million and each call might be for roughly 10% of the commitment, so an investor would have to wire $100,000 within 10 days).
- Funds work hard to minimize the number of capital calls to keep things simple for limited partners and often use a line of credit to smooth things over (e.g. shoot for 2-3 capital calls per year, but if there’s additional investment activity between the calls, use the line to move quickly and make another investment).
- If the fund has some early exits, there’s a real chance that the limited partners don’t have to invest their full commitment because the proceeds from the exits will cover some of the capital (e.g. with some wins, a commitment of $1 million might only result in $700,000 in money invested by the limited partner).
- Since capital is called over the course of the investment period, typically 3-5 years, and done in a piecemeal fashion, investing $1 million in a venture fund doesn’t require having $1 million in cash, but rather ~$200,000 per year for five years.
Commitments, capital calls, a line of credit, and exit proceeds make cash flow in a venture fund more challenging than expected. The next time you read about financing from a venture fund, think about everything that went into it.
What else? What are some more thoughts on cash flow considerations in a venture fund?
David Cummings on Startups 