
How VCs get paid - haxplorer
http://jtangovc.com/how-vcs-are-paid/
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tptacek
This was a surprisingly interesting article.

The 2-and-20 structure is well known, but the management company details were
fresh for me.

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larrys
Very interesting.

But this:

"First, the Chief Partner cannot be fired without his/her consent. Every other
partner at a VC firm can be, including the ones who have worked hard to earn
pieces of the management company. So, a partner at a venture firm is usually
an employee-at-will. They can be fired at any time."

and this:

"I want to point out that this type of ownership structure is usually the norm
in other asset classes."

But then they do it this way (edit: pitched as "why we are better for you"):

"when Eric joined the management company, he received his shares for free. So,
we are equal partners and equal owners."

What is lacking here is some data highlighting how typical the practice is of
partners being able to be fired "at will" edit: and how many firms deviate
from the practice of "every other partner can be fired". How often does that
happen? The OP points out that they don't do it that way (at least not with
the two partners mentioned). So what percentage of VC firms operate in a
similar way?

Also, how typical is it even if it is this way for a partner to get fired
because business is bad? If you were from Mars and learned about speed limits
you would think you get a ticket for going 56 mph in a 55 zone. But of course
that is accepted to be a rare event.

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tptacek
It's possible that overt firing may be rare, but what would amount to
constructive termination wouldn't be (I assume all you have to do to
constructively terminate a VC partner is to veto their deals at partner
meetings); I've talked to VCs who left larger funds to start their own, and
perhaps stuff like that is why.

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larrys
Until reading this, and assuming true, I was always impressed with someone who
was a "partner" at a VC firm. Thinking of it similar to being a partner at a
better law firm vs. an associate. Associates leave if they don't make partner
(used to be 7 years but that has changed obviously).

(I mean I was probably 10 when I found out that at a bank everyone is a Vice
President.)

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cluda01
Considering that finance types frown upon founders having monopoly control of
their companies, why would LP's agree to this sort of structure?

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vm
Two reasons LPs do this:

1\. Investing in the best funds is competitive for LPs. Top funds often have
more demand for investment than the fund will accept, so the partners have
greater leverage to dictate terms. It's like an entrepreneur having multiple
term sheets.

2\. The big bucks come from fund returns, not management fees. In this sense,
LPs and partners are highly aligned, since 80% of those returns go to LPs
(assuming a 20% carried interest fee - obviously this varies by fund).

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tptacek
Wait, didn't Kauffman suggest that many funds were getting most of their
returns from fees? That the fee structure was encouraging the creation of huge
funds so that partners could profit from those fees, despite the fact that
larger funds are harder to invest well? That most funds are underperforming
the market?

Kauffman's portfolio included Bessemer, Benchmark, and General Atlantic, among
others. They weren't talking about shady funds.

If you really are expecting to get a giant locked-in chunk of your return from
fees, than the interests of partners and the "chief partner" are not
necessarily aligned.

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vm
No, Kauffman simply said returns were lower for big funds and generally higher
for small funds. But it doesn't really matter - most funds actually pay
management fees back to LPs before they're allowed to generate carried
interest.

For example, if a fund earns $10M in management fees, it would pay back that
$10M from the first returns generated by the fund. Then, only after getting
"breaking even," would the partners earn carried interest. If the fund doesn't
hit that watermark, it loses money for investors.

There are exceptions, though most of the industry has moved this way.

For those who haven't read the report, it's here:
[http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-
report....](http://www.kauffman.org/uploadedFiles/vc-enemy-is-us-report.pdf)

Personally, I don't put much weight into it. It's conclusions are heavily
skewed by the decade after 2000, which destroyed returns for most investing
asset classes. (Despite the report's claims that it covers "20 years" of
funds, most charts and examples, esp about mega funds, are recent).

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tptacek
Thanks. I had been reading political crud about PE firms and re-skimmed the
Kauffman thing looking for confirmation.

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patdennis
As an interesting aside, I'm pretty sure the technique used in this related
post: [1] is how the press figured out that Romney was involved in Bain
Capital after his supposed departure in 1999.[2]

[1] [http://jtangovc.com/vc-economics-and-control-unveiled-on-
the...](http://jtangovc.com/vc-economics-and-control-unveiled-on-the-web/) [2]
[http://www.latimes.com/news/opinion/opinion-la/la-ol-mitt-
ro...](http://www.latimes.com/news/opinion/opinion-la/la-ol-mitt-romney-bain-
capital-departure-date-tempest-20120713,0,6775629.story?track=rss)

