Tag Archives: how venture capital make money

Venture Capital Funding Model– Danger of Dying, Irrelevancy: VC Firms, As Asset Class, Have Utterly Failed…

The story of venture capital (VC) appears to be a compelling narrative of bold investments, excess returns… however, the reality looks very much different. Behind the anecdotes about– Apple, Facebook, Google… are numbers that show many more venture-backed start-ups fail than succeed… and VCs themselves are not much better at getting good returns… According to Fred Wilson; biggest issue is simply too much money– billions of dollars continues to flow unabated into venture-backed companies but venture capital firms as an asset class have not outperformed other investments, e.g.; the stock market… since the early 90’s and will probably deteriorate further...

Things look even bleaker when you add in the additional billions that angel investors dish out, and growing interest from places like– Russia, Middle East, China… and rise of accelerator programs like; YCombinator, TechStars… and financing options like; Kickstarter, crowdfunding… According to Kaufman Report; many  institutional investors continue to pour money into these funds despite VC’s abysmal track record… The traditional venture capital landscape is shifting and VC’s must begin to rethink their business models and herd mentality that dominates the industry…

In the article How do Venture Capitalists Make Money? by Draper writes: Venture Capitalists are money managers, they raise money and manage it for other people who are the ‘limited partners’… The normal venture capital (VC) firm will raise on the–  ‘2 and 20’ terms. The ‘2’ is in reference to the management fee, which means every year, 2% of the funds raised go toward operations of the firm… So if a VC raised $10,000,000 fund, the fund would have an annual operating budget of $200,000 for life of the fund (generally 10 years). The ’20’ is in reference to ‘carried’ interest… VCs make most money off of the ‘carried’ interest rather than management fee…

This basically means that the venture firm gets 20% of the upside after they have returned the money being managed… Which is why venture capital is built on moon shots and not safe bets. Safe bets might give you 3–5x return over 7 years, but something like Google, could give you 10,000x… These are the normal numbers that many funds use, but every venture firm is different, In summary, VC firms are  paid in two ways:

  • Management fees: 2%/year of funds under management is common; over the ~10 year life of a fund, that’s ~20% of the capital…
  • Carried interest: This is a share of the profits on the fund before the money is returned to investors. The typical number here is 20%…


In the article End of the Management Fee in Venture Capital by Paul Grossinger writes: The ‘management’ fee is going the way of the landline for all but a handful of top-notch VC firms… Since the advent of traditional early stage venture capital in the 1980s, the industry has been dominated by a dual-compensation model; a management fee, to pay for running the firm over its lifetime, and a profit ‘carry’, to give upside to the partners… However, a new crop of investors are seeking to end the dual-compensation model… and reduce or end use of management fees and instead rely only on profit ‘carry’…

This charge is certainly not absolute or applicable in 100% of cases. Many traditional venture capital funds have strong, long track records and have produced excellent returns and the earned right to continue operating under whatever model they see fit. But majority of funds under management do not have such sterling returns. In fact, more than half of traditionally structured VC funds actually lose money. Contrast that with the ‘returns’ of active angel investors, individuals, which are much higher…

In the article Venture Capital Salary & Compensation by WSO writes: Successful venture capitalists can make a very nice living with less risk, and less chance of burnout than entrepreneurs… From analysts and associates to managing directors, venture capital salary is traditionally heavily weighted toward the bonus portion of the compensation, as well as ‘carry’… Much like private equity, venture capital compensation has a broad range but it’s usually a function of the fund’s performance, and much of compensation is tied up in ‘carry’, which can be rather large payout… According to Wall Street Oasis; rough VC compensation ranges based on user registration data is shown as follows:

  • Analyst: $80K – $150K.
  • Associate: $130K – $250K.
  • Vice Presidents: $200K – $250K + $0-1MM ‘carry’ bonus.
  • Principal/Junior MD: $500K – $700K + $1-2 MM ‘carry’ bonus.
  • Managing Directors/Partners: $1MM + $3-9MM ‘carry’ bonus.

In the article Venture Capital Is Dead. Long Live Venture Capital by Erik Rannala writes: There are rumblings that the traditional VC business model could be in danger of extinction, threatened by more contemporary investment sources such as; crowdfunding, super angels… While it’s true that the early-stage funding landscape is changing, VCs are hardly on the demise, nor are professional VCs losing ground to– crowdfunding, angels… Rather than looking at the funding landscape as a zero-sum game with one model rising up at the expense of another, it’s best viewed more as a continuum, with investors across the spectrum matching up with companies at the right stage of development or maturity…

Venture capital as an asset class has utterly failed and some suggest more than 1/3 of about 790 venture capital firms have turned into living dead… However, the venture capital lobbying organization (the NVCA) feverishly attempts to dampen the demise of the reputation of venture capital by quoting nebulous IRR (Internal Rate of Return) statistics that often hide the fact that relevant absolute performance comes from just a small number of firms…  According to Georges Van Hoegaerden; venture capital in its current form and deployment is by economic principle incompatible with finding the outliers of innovation…

It’s ironic, VC firms position themselves as supporters, financiers, and even instigators of innovation, yet the industry itself has been devoid of innovation for the past 20 years. Venture capital has seen plenty of changes over time– more funds, more money, bigger funds, declining returns but VC firms have not changed– they are structured, capital is raised, partners are paid… just as they were two decades ago. The VC industry that purports to be the promoters of innovation are, in fact, being out innovated from outside their own industry…