A VC - Latest Comments in Venture Fund Economics

Re: Venture Fund Economics

Ted Rogers — Wed, 13 May 2009 14:25:30 -0000

I rank this and the follow up post as the #3 VC posts of All-Time. Thank you, Fred!!

Re: Venture Fund Economics

fredwilson — Wed, 10 Sep 2008 14:34:14 -0000

Yes you do

The theory is it takes a lot of work to source and close the investments. I'm not sure I buy that argument but that's how its done

Re: Venture Fund Economics

Bob — Wed, 10 Sep 2008 14:02:56 -0000

If the management fees are calculated on committed capital, but it is not yet called don't you end up with a disproportionate share of money going to the fund managers early relative to investments?
Thanks

Re: Venture Fund Economics

fredwilson — Wed, 06 Aug 2008 11:04:07 -0000

Yes but its not the IRR/idle cash issue. Its that they want to get their money to work to meet their allocation targets

Re: Venture Fund Economics

Mark MacLeod — Wed, 06 Aug 2008 10:45:40 -0000

Do you ever get pressure from LPs who would like their money put to work sooner? Since they have to invest it productively until you make a capital call

Re: Venture Fund Economics

tom g — Wed, 06 Aug 2008 02:57:21 -0000

in roman numerals I meant to say

Re: Venture Fund Economics

tom g — Wed, 06 Aug 2008 02:56:12 -0000

I think it's because M stands for a thousand, so MM is a thosand times a thousand

Re: Venture Fund Economics

fredwilson — Tue, 05 Aug 2008 06:17:04 -0000

The answer to the first question is ³it depends². There are secondary share
buyers who often will pay cash for the remaining illiquid shares in a
venture portfolio and I believe that is the best way to liquidate a fund.
But yes, LPs sometimes do get illiquid stock. It's not a good idea in my
mind though.

The answer to the second question is that will only work once. If you do
that, you'll never raise another fund from LPs. It's a small world and
reputations last a long time.

Re: Venture Fund Economics

Guest — Mon, 04 Aug 2008 21:59:38 -0000

Thanks, Fred
I have a couple of questions:
1. What happens to private shares at the end of a fund's life? I assume they get distributed, correct? How would this impact the carry? Are they at all counted in calculating the carry? Can you reallocate your distribution, where for example you take out your carry only as cash/public shares and stick the LPs with all the private shares? That would really suck for the LPs. This issue is probably very relevant in today's "scarce exits" environment.

2. How are the LP's protected from fund managers that optimize the risk profile of the fund towards their own interests. Here is a hypothetical example: you have a venture fund (let's call it hypothetically OVP) that is way underwater. They get a buyout offer for a portfolio company of $100M, which would still keep them underwater (no carry either way). The GP's interests are to hold out for a better deal, say $500M, even though it is very unlikely, which would put the fund in the black and allow them to collect some carry. The chances of the company being bought for $500M are super-small, but since there is no downside for the manager, their incentive is to hold out for this lottery shot. On the other hand the LPs would like to at least get some of their money back. What are their recourses?

Thanks again for this series!

Re: Venture Fund Economics

fredwilson — Mon, 04 Aug 2008 17:38:06 -0000

Thanks

It was caused when I changed my domain to avc.com

When I saw it I realized what happened and fixed it

Thanks

fred

Re: Venture Fund Economics

Ryan — Mon, 04 Aug 2008 13:26:58 -0000

Although the VC investor doesn't relinquish all of the committed cash up front, but instead distributes it over a series of capital calls over several years, shouldn't the investor consider the opportunity cost that results from the liquidity requirements of this commitment when measuring return?

Re: Venture Fund Economics

Joseph Stafura — Mon, 04 Aug 2008 11:40:17 -0000

As a participant in a fund of fund, vintage 2000, I would be delighted to get to 2x at the end of 2010. Another factor that is not mentioned is that at some point the distributions are used to fulfill the cash calls so while you are contractually bound, by pretty severe terms, for the full amount most performing funds will stop taking your money after 4-6 years.

Re: Venture Fund Economics

themaria — Mon, 04 Aug 2008 11:38:50 -0000

Fred / Disqus Team:

I clicked through to this original post to follow the link from today's post. It seems that all but 2 comments have disappeared. Seems to be a consistent situation in other posts. Thought I'd give you the heads up that comments aren't showing up in Disqus, although the current post seems to be OK.

Re: Venture Fund Economics

Derek Scruggs — Mon, 04 Aug 2008 11:12:48 -0000

...you will likely be earning something closer to 13% than 8% just because the $1mm wasn't tied up in the fund for the entire ten years.

Yeah but... Since that capital is contractually committed, wouldn't a prudent investor put the money somewhere safe like treasury bills in the interim? Or is there no penalty if that money gets blown away in a riskier investment and, therefore, the investor declines to meet your capital call?

If you assume they keep it somewhere safe, then I don't think it's a sound argument for you to assume returns will be higher. Likely they are the same or lower, esp on a risk-adjusted basis.

Re: Venture Fund Economics

Bruce Hamm — Mon, 04 Aug 2008 10:57:31 -0000

Fred, if the LPs can be called to make capital contributions on short notice, or at least must have the money liquid to live up to their commitment to the fund, would they not have to have such funds in low-return liquid vehicles which would lower their total return for the money over the time frame even if the VC is using the capital productively while in its possession?

Re: Venture Fund Economics

sent2null — Sun, 03 Aug 2008 16:11:46 -0000

which pisses me off since I am an Engineer and have become use to using "K" to describe measures of 1,000 .....yes the "M" likely comes from the roman numerals....as in engineering "M" is mega or million....so I wince every time I see "CPM" ;)

Re: Venture Fund Economics

Alex Hammer — Sun, 03 Aug 2008 10:54:22 -0000

Theoretically, such algorithms can be devised via reverse-engineering. You look at the ROI results of your or others investments, and then you work to identify and quantify the contributing elements to that result. You keep tweaking the algorithm until it best fits (predicts) the result. Then you move on to other results to see whether the algorithm just created also (best) predicts this other result, whether it needs to be further modified, or whether this new result requires its own separate (but perhaps related) alogorithm

Re: Venture Fund Economics

Chris Yeh — Sun, 03 Aug 2008 10:42:00 -0000

I believe that $1MM comes from the practice of using "M" to stand for 1,000. That's why we use the term "CPM" for cost per thousand.

My guess is that "M" actually comes from the Roman numeral.

Re: Venture Fund Economics

Alex Hammer — Sun, 03 Aug 2008 10:30:31 -0000

Very useful and illuminating post.

I am not a VC so am not sure the standard practice, but it seems to me that while, far from being completely scientific and predictable, a VC firm could (potentially) model well potential rates of return from an investment with a well developed (and finely tuned) (set of) algorithms that take into consideration, among other factors, current and historical returns in that sector, types of exit(s) available and predicted, predicted strength of team and operations, market opportunity filtered by assessed competence relative to competitors etc.

Not to say that investing isn't also an art, but in any complex phenomenon being able to quantify into (accurate) predictivfe models is important.

Techmeme is used because it distills what is important/popular with readers, and people argue about how well and accurately it does this.

EFFECTIVE ALGORITHMS SEPARATE VALUE FROM NOISE. One thing that they do not inherently do, however, is integrate vision and disruption, those types of variables - highly important - need to be included as well.

Re: Venture Fund Economics

Liz — Sun, 03 Aug 2008 10:18:13 -0000

Interesting. I actually have a degree in Economics but my course in Corporate Finance was only one quarter long (10 weeks!). We spent most of our time on International Development and zip on Personal Finance. Lots of macro, almost no micro beyond Accounting. So, I'll be interested in reading your series. I'm still basically a Marxist but it helps to know the other side ; ) . A Marxist who uses smiley faces (you're looking for diversity, right?).

Re: Venture Fund Economics

kosso — Sun, 03 Aug 2008 10:07:38 -0000

;) thanks. I've seen it elsewhere too. Thanks for clearing that up. Always seemed odd.

Re: Venture Fund Economics

fredwilson — Sun, 03 Aug 2008 09:43:06 -0000

It's a habit of mine

Maybe a bad one

I've been doing it since I was taught to do that by the first venture firm I
worked for in 1986

Re: Venture Fund Economics

kosso — Sun, 03 Aug 2008 08:34:57 -0000

Interesting post Fred. Thanks.

But one thing that I've always wondered about is, why do people write $1million as '$1mm' instead of '$1m' ? It doesn't make sense, especially as 'million' only has one 'm'. ;)

Re: Venture Fund Economics

fredwilson — Sun, 03 Aug 2008 08:24:04 -0000

Here's what I wrote this morning

http://avc.blogs.com/a_vc/2...

Re: Venture Fund Economics

Jens — Sun, 03 Aug 2008 08:09:18 -0000

This is an important point.

Venture Xpert etc have no way of measuring net returns, they can only look at a money invested vs. exit volume multiple. This is highly misleading. It ignores transaction costs (lawyers, bankers, etc), the shares that goes to founders and management, and it ignores management fees and carry. I have put together a quick spreadsheet that includes the costs here:

http://jenslapinski.wordpre...

Would love to hear your view on this.