RTC #8: How VCs make money

Why today’s issue is valuable to you 💎

1. Headlines: 80% of pitches now involve AI, quite a few AI companies are most likely to go public, many startups with munch longer funding circles, and Google invests in sports virtual reality, and more!

2. Today’s Deep Dive: How do VCs make money? Understand how the VC model works to become a pro on management fees and carry, and find out how much VC partners and associates took home last year

3. Extra: We compiled the top 2024 VC events. If you are thinking of meeting any VC this year, this is your calendar on where to find them

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Headlines 📢

• More than 80% of pitches now involve AI

• IPO Watchlist: AI and machine learning startups that are most likely to go public

• Time to the next funding round is taking longer for startups as the number of days between primary rounds has lengthened

  • On the one hand - founder-driven: have cut spend and become more capital-efficient over the prior 12 months

  • On the other hand - VC-driven: VCs are far more choosy about where to invest

• M&A dropped 31% for VC-backed startups in 2023

• Google invests in sports virtual reality startup StatusPro

• Blockchain startups: other investors outpace crypto corporate venture-capital arms (part of major exchanges and trading firms)

• Snap (the parent company of snapchat) is cutting 10% of its workforce as part of a restructuring plan

🤿 Deep Dive: How do VCs make money?

The Venture Capital industry has four main players

• Entrepreneurs: they need funding

• Investors: they want high returns

• Investment Bankers: they need companies to sell

👉 plus Venture Capitalists who make money for themselves by making a market for the other three 💰💡

Compensation structure

The 2/20 model is THE standard compensation structure for venture capital funds (as it is for hedge funds and private equity).

It consists of two main components:

• '2' refers to a (typically) 2% management fee

• '20' refers to a (typically) 20% carried interest (“carry”) - this is the performance fee

There are variations depending on the fund size, track record, investment strategy, etc - more on the exceptions further below.

Management Fee

This fee is typically calculated on an annual basis, taking into account the total committed capital from the limited partners (these are the people who put the money in the fund). Important: committed capital and not the capital actually paid in (so-called “called capital”).

It is designed to cover the operational and administrative expenses incurred during the fund's lifespan - paid regardless of the fund’s performance.

Typical expenses are:

• Salaries (I will show the figures in a minute!)

• Set-up costs (at the start)

• Legal and tax costs for fund administration

• Research, databases, and due diligence

• Travel and networking

Let’s calculate an example:

• Imagine you have a $50m venture fund

• This means that your investors have $50m committed (which they will pay in over the first 4-5 years in more or less equal tranches)

• You charge a 2% management fee that amounts to €1.0m from year 1, yearly onwards for the duration of the fund

Some insights from Carta on current trends:

➡️ A 2% fee is most prevalent, especially in funds under $100m
➡️ Over half of the small funds managing $10m million or less charge a 2% fee
➡️ For larger funds, the median fee rate rises to about 2.5%. Nearly three-quarters of those handling $500m or more can impose a 2.5% management fee

Carried interest (“Carry”)

Carry is the performance fee to the general partners (these are the people who manage the fund) typically paid out after the investors/LPs have received a return on their investment (Preferred Return)

• Preferred Return: This is usually 1x their original investment increased by a hurdle rate, which is the minimum rate of return required

• Carry is paid after ensuring that all initial investments, operating expenses, and preferred returns to LPs have been accounted for

• It's a long-term incentive and isn't distributed until the fund starts creating positive returns from successful exits — this can take several years

Let’s calculate (the same) example:

• $50m venture fund

• The preferred return is 1.5x

• To achieve the 1.5x, the GPs need to return $75m before any carry is distributed to them

PLUS: you better be a (or better the number one) partner: in most firms, carry is divided up (often, unevenly) between the general partners and with a smaller amount for the junior/non-GP pool 👇

Return profile of VCs

Returning 4.0x - this seems not so difficult?! You will be surprised…😲

The latest data show that only 12.5% of the VCs out there achieved to return of more than 3.0x to their investors. 👇

And there are big differences across the funds…. 👇

VC Salary Data

I promised you at the beginning that I would provide you with more details on the top expense (salaries) and here it is…the latest VC Salary Data for 2023 across positions 👇

Calendar of main VC events 🤝

Fundraising advisor or startup coach?

👉 Start building and maintaining your own investor relationships

Startup founder and/or responsible for capital raising efforts?

👉 Start building and maintaining your future investor relationships

Veteran VC or new entrant to the industry?

👉 Start building and maintaining your fellow investor relationships

No excuses…it is all there 👇👇👇

📅 Upcoming Events in 2024

February
• Tech Tour Growth Europe | Paris, France | Feb 8
• Finovate Europe | London, UK | Feb 27-28
• 4YFN | Barcelona, Spain | Feb 27-29

March
• SuperReturn Private Credit Europe | London, UK | March 11-23
• Mind the Tech | New York, US | Mar 4-5
• Hello Tomorrow | Paris, France | Mar 18-22
• GPC Conference | New York, US | Mar 25-27

April
• Energy Tech Summit | Bilbao, Spain | Apr 10-11

May
• Private Debt Investor Europe Summit | London, UK | May 7-8
• EU-Startups Summit | La Valletta, Malta | May 9-10
• Tech.eu Summit | London, UK | May 16-17
• Viva Technology | Paris, France | May 22-25

June
• NOAH Conference | London, UK | Jun 3-4
• SaaStr Europe | London, UK | Jun 4-5
• SuperVenture | Berlin, Germany | Jun 4-6
• Money20/20 Europe | Amsterdam, The Netherlands | Jun 4-6
• Bits & Pretzels HealthTech | Munich, Germany | Jun 5-6
• South Summit | Madrid, Spain | Jun 5-7
• TNW Conference | Amsterdam, The Netherlands | Jun 20-21

September
• TechBBQ | Copenaghen, Denmark | Sep 11-12
• Carbon Unbound Europe | London, UK | Sep 11-23
• France Digitale Day | Paris, France | Sep 18
• B2B Rocks | Paris, France | Sep 25-26
• TechChill Milano | Milan, Italy | Sep 25-27
• Italian Tech Week | Turin, Italy | Sep 25-27
• The Drop | Malmo, Sweden | Sep
• Bits & Pretzels | Munich, Germany | Sep 29 - Oct 1

October
• Sifted Summit | London, UK | Oct 2-3
• World Summit AI | Amsterdam, The Netherlands | Oct 9-10
• SaaStock | Dublin, Irland | Oct 14-16
• The Business Booster | Barcelona, Spain | Oct 16-17
• TechCrunch Disrupt | San Francisco, US | Oct 28-30
• 0100 Conference Mediterranean | Milan, Italy | Oct 28-30

November
• WebSummit | Lisbon, Portugal | Nov 11-14
• Slush | Helsinki, Finland | Nov 30 - Dec 1
• Health Tech Forward | TBD | Nov
• The Big Score | Ghent, Belgium | Nov

This was it for today!

If you found it valuable, let a friend know (and receive one or more of the exclusive Road-To-Capital perks!)

See you next Tuesday,
Stephan 👋

Issue #8 | 6 February 2024