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How VCs Make Money

vcstarterkit.substack.com

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Re: How VCs Make Money

#11

Post by vcstarterkit »

refrigerator wrote: post #2

Brilliant post — very informative + clearly written. > What goes unsaid, is that only the actual partners in the fund get any carry, associates just get a comfortable salary and the prospects of becoming a partner (at another firm obviously) "(at another firm obviously)" — I've heard this in other discussions about VC careers too. Why is it the case?

Partners have two jobs at firms: raise money from LPs and convince great founders to take the firm’s money. If you were hiring a partner you would choose to go in this order: poaching a star partner from another firm, hiring a star founder/operator, an all-star associate at a more successful firm, promoting your own associate.

Any of the first three options will help sell LPs and founders on your new fund by bringing along some brand name credibility. It’s a harder sell when you are promoting from within, especially as associates do not have experience raising money from LPs.

Another reason: Venture firm partnerships are inherently political environments and perception matters. It is akin to why grad students are discouraged from becoming professors at the same school they got their PhD from. It’s hard to escape from the shadow of your mentor and find your own footing.

There a few other reasons that promotions are rare, but they do happen. A16Z used to have a rule where no one internally would be promoted to be a GP because they only wanted to have former operators be partners (they have now since changed that policy https://a16z.com/2018/07/17/connie-chan/)

Re: How VCs Make Money

#12

Post by harveyesq »

Roritharr wrote: post #5

I've sometimes wondered if transitioning from CTO to VC makes sense/is possible, has anyone tried that?

The TL;DR here is that it's possible to transition into a VC role as a former CTO but it's not a common pathway.

Many VCs have followed a standard pathway from Harvard/Stanford/Whartonn MBA into a fund (because it checks the boxes of LP due diligence) , but if you are looking to shortcut that process, then you have to consider how other VCs got their start.

The great debate in VC is whether Operator VCs (those who have founded or operated a business) are better suited to VC than Investor VCs (those who haven't founded or operated a business, like most Wall Street types)?

The data indicates there is no clearcut answer. You can read the CB Insights analysis here: https://www.cbinsights.com/research/founders-best-venture-ca...

Also, Fred Wilson (@AVC) wrote an article that indicated investor VCs make the best kind of VC more often (which of course can be analyzed otherwise): https://avc.com/2017/05/investor-vcs-and-operator-vcs/

The important things to note are that 1) VC is not monolithic and 2) VC is multi disciplinary.

The best VC fund managers need to be great at raising capital, have excellent deal flow/selection, know how to communicate, negotiate and close deals, be valuable board members, manage a fund portfolio and exit portfolio companies to return capital to the fund's LPs.

Finally, here are the top three reasons why Fred Wilson thinks many of the best VCs, at least of his generation, were not entrepreneurs and operators before becoming VCs: 1. Manage People. Avoiding the temptation to operate and instead managing well from a distance. 2. Strategic Mindset. Understanding where value is going to be in an emerging market, how to get to the best strategically positioned companies first, and how to guide those companies toward a strategy that wins the market. 3. Being a portfolio team player by wearing many hats and ultimately doing whatever it takes to help solve the startup founder's biggest problems.

Also see,

“Investor vs. Operator VC” by Rory Stirling https://link.medium.com/nIPkvG31z1

Re: How VCs Make Money

#13

Post by DrAwdeOccarim »

harveyesq wrote: post #3
refrigerator wrote: post #2

Brilliant post — very informative + clearly written. > What goes unsaid, is that only the actual partners in the fund get any carry, associates just get a comfortable salary and the prospects of becoming a partner (at another firm obviously) "(at another firm obviously)" — I've heard this in other discussions about VC careers too. Why is it the case?

Because it takes 10 or more years for one fund to run its course. If the associate stays with the VC firm, it's a long uphill road rising to the top. The fastest shortcut is to jump over to another firm that needs that associate's skillsets, and might even be open to issuing a profit's interest (split off of carry).

And they can also probably file 83(b) elections claiming the profits interest have zero value to start the LTCG clock and avoid wage tax...

Re: How VCs Make Money

#15

Post by ninkendo »

This article needs to define its terms. What is a GP? Sure I can google it but this is supposed to be an article that explains that kind of thing, I may as well just google how VCs make money and read a different article.

Re: How VCs Make Money

#17

Post by harveyesq »

refrigerator wrote: post #8
harveyesq wrote: post #3

Earlier quoted context omitted.

Because it takes 10 or more years for one fund to run its course. If the associate stays with the VC firm, it's a long uphill road rising to the top. The fastest shortcut is to jump over to another firm that needs that associate's skillsets, and might even be open to issuing a profit's interest (split off of carry).

How come they need to wait til the whole fund to run its course before bringing on new partners? Don't they raise new funds every few years, before old ones have entirely exited?

Yes but the average partner per fund for microVC (under $100M) is less than 2 people (1.94 is the average). So unless you're working for a large VC platform with several funds and plenty of room on the team's cap table, you're waiting patiently on the sidelines of a very long game.

Re: How VCs Make Money

#19

Post by harveyesq »

ninkendo wrote: post #15

This article needs to define its terms. What is a GP? Sure I can google it but this is supposed to be an article that explains that kind of thing, I may as well just google how VCs make money and read a different article.

GP = General partner;

LP = Limited partner

GPs are the VCs, the ones wearing Patagonia puffer jackets. LPs are the actual investors, including pensions, endowments, sovereign wealth funds, high net worth individuals, and on occasion, larger institutionals like hedge funds and publicly traded corporations.

Re: How VCs Make Money

#20

Post by fnord123 »

xorfish wrote: post #14

So if 2/3 of the funds income is from the management fee, wouldn't that mean that the average VC fund clearly underperforms the market?

If management fees are 2/3 of the fund's income then the management is twice the performance fee. Given value of fund at start (f_0) and value of fund after a time period (f_1) then the value is:

    0.02f_1 = 2( 0.2 ( f_1 - f_0))
    f_1 = 20 (f_1 - f_0)
    20 f_0 = 19 f_1
    f_0 = 0.95 f_1
    f_1 = 1.053 f_0
So management fee is 2/3 of the income if the performance is 5.3%. SPY performance is all over the place[0] but you can see years with 10% or 20% growth.

But check my math because I'm a moron.

[0] https://finance.yahoo.com/quote/SPY/performance/

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