

Ask HN: How do VCs hedge their risk? - MalcolmDiggs

I&#x27;m wondering if there is some kind of hedging mechanism for private equity that I&#x27;ve never heard of.<p>If you looked at a VC&#x27;s portfolio, would it be truly 100% long? Or are they figuring out a way to take a short position in private companies? (Either literally or through something akin to Credit Default Swaps, etc)?<p>Any insight, or precedent would be appreciated.
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matthewmcg
You need to distinguish between the VC fund and the VCs.

The VC fund is the entity that holds shares in the portfolio companies. The
fund is purely long and unhedged. They try to minimize losses by being
selective about their investments and negotiating contractual protections that
reduce their downside risk (e.g. anti-dilution protection and redemption
rights). But at the end of the day, they hope that their portfolio will
include enough successful exits to cover losses and unsuccessful exits.

The VCs themselves are investment managers. They control the investments of
the fund and they are generally compensated based on (a) percentage of the
assets under management and (b) a percentage of the return.

(a) is supposed to enable the management firm to pay staff and support the
costs of finding and managing investments. (b) is supposed to incentive the
managers to maximize returns to the limited partners providing capital to the
fund. In practice it's a bit muddier, as sometimes the managers will defer
fees or co-invest in portfolio companies alongside their funds. But the basic
idea is that the managers will make _some_ money regardless of how the fund
does, and they stand to make a lot more if the fund does well. You might
cynically say the managers are "hedged" even though that is not strictly true.

A better question is whether venture capital (or private equity, for that
matter) performs well as an asset class after all of these fees. See, e.g.
[http://www.kauffman.org/~/media/kauffman_org/research%20repo...](http://www.kauffman.org/~/media/kauffman_org/research%20reports%20and%20covers/2012/05/we%20have%20met%20the%20enemy%20and%20he%20is%20us\(1\).pdf)

