Just as each VC fund is different, the fee structures of these funds also varies. At first glance, the fixed charges of VC funds may give the impression they’ll still get paid even if they don’t do their job well, or at all. By taking a deeper look into fee structures of VC funds, we see there is much more to how VC funds make money for their investors and themselves.
VC Firms’ 2-and-20 Fee
The typical fee structure of VC funds is known as 2-and-20. Most VC funds will keep 2% of the fund’s total amount each year (called a management fee) and use it to cover operating expenses and pay salaries. In addition to management fees, VC funds usually keep 20% of the profits for their own investors, known as carried interest or a carry fee. You can think of this carried interest like equity in a startup. Some VC funds take up to 30 percent based on what they specialize in and their track record.
It is important to note how management fees and carried interest work together in the fee structure. The biggest point to note is that the fund’s return is calculated as net against the management fees. This means VC firms charging higher management fees must generate a larger return for their investors in order to receive carried interest payments. In fact, a VC firm generating a return less than the amount of management fees would not receive any carried interest payments.
So why wouldn’t all VC fund structures include low management fees in order to reap a larger carried interest reward?
Many VC funds have fee structures with what might be seen as “high“ management fees because they deal with high-risk levels, legal costs, fund creation fees, and other factors. With these factors absorbing most of the management fee, a VC fund must rely on carried interest to see real revenue. Thus, these firms must generate large returns for their investors in order to see large returns for themselves. Managing money is a service. Like any other service, some VC funds are able to charge a premium because of their brand name and previous track record.
In order to learn more about a fund’s fee structure, closely review their Private Placement Memorandum (PPM) and Fund Summary. This is where all funds disclose how and when they are compensated for their services. Each of MicroVentures offerings’ contains both documents attached to each startup available for investment. Review these documents thoroughly prior to investing and let our brokers know if you have any questions.