What is the 2% and 20% VC fee structure?
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Hey, it's Scott Orn at Kruze Consulting, and today I'm answering the question: What is a two and twenty VC fee structure?
And two and twenty is basically the standard fee structure for venture capital firms to charge their investors. And it's a two parter. The two, 2%, stands for management fees applied against the value of the fund every year. So basically, especially in like the first five years of a fund, you'll have a 2% management fee, basically the active investing period of the fund. The investors get to charge their limited partners, the investors in the fund, 2% annually on the value of the fund. So if you have a $100 million fund, that's $2 million in fees every year. You get to charge to pay all the partners and all the support people, and all the legal costs, and fund administration expenses and all that kind of stuff.
The 20%, or the 20, applies to the profit sharing, better known as "carry" in the industry. Once the investors, the general partners, distribute capital back to all the investors, they get their money back, a hundred percent back, then every dollar after that, there's a profit share component. And 20% is basically the standard that venture capital general partners get to charge the limited partners. So every 20 cents on the dollar is profit that goes to the general partner. So say you have a $100 million fund, you deliver an additional $100 million of profit, so you return $200 million to your investors. Well guess what, 20% of that extra $100 million you we're going to return, is profit for the GP's.
So you actually are returning $80 million to your investors. And the general partners get to split $20 million of profits. You can see how this can become pretty lucrative. If the VC fund's doing well and making good investments, a 2X return, which as I just kind of explained, isn't even that great really. A lot of times venture capital firms need to return at least a 3X. So the profit participation or carry, is actually very, very attractive. That's really what most people are working on a VC fund for. They could make a lot of money in some other positions in management positions at startups or public companies, but the profit share or carry, is what gets them out of bed everyday and working very hard.
Although I think most, the best VC's are all just intrinsically super motivated people and want to change the world. So it's not really, money doesn't motivate them 100%, but hey, it's a nice component. There's also, I should also point out that two and twenty is kind of like the industry standard, but if you're an incredible firm and have a track record of making great investments, and have tons of limited partners that want to invest in your fund, well you can probably charge more. Sometimes you see the funds charging 3% management fees and 30% of profits.
There's a bunch of different, at the very, very high end with the best firms, there's a bunch of kind of tweaks or incentive structures on that carry that can deliver even higher returns to the general partners. Also should state that, like I said, the management fee is typically over the active investment period, usually the first five years. And then it starts stepping down. Sometimes it's like 25 basis points per year. So a couple years after the active investing period, you're down to one and a half percent management fee, one percent management fee, and so on as the fund ages. And the logic with that, is there's just not as much work, not as many people you need to pay to run the fund. It's kind of in runoff mode. Still some work.
Still audits, and financial people, and managing the portfolio, but it's just less burdensome for the GP's, and so they charge less fees. So hope that helps. Two and twenty is a term you will hear quite a bit if you're at a cocktail party or you know a venture capitalist, or know limited partners, and often for the best funds they get to charge a premium to that, but it is kind of industry standard for most funds to charge two and twenty. Hope that helps.
If you have any other questions on venture capital backed startups or funds, or whatever it is, hit us up at kruzeeconsulting.com. Thanks.
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