Inside Venture Capital: Do VCs Make Less Than You Think?

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Inside Venture Capital: Do VCs Make Less Than You Think?

 


For some reason, I find myself reading a fair number of VC blogs.  This is mostly out of curiosity.  Though I’ve never raised venture capital for a startup before, I find the industry interesting. 

 

What’s disappointing about VC bloggers is how few VCs actually write about the internal workings of their industry. This is why, the venture industry continues to be reasonably opaque to most people that are outside the business.  Sure, you can read about how VCs make money (management fees, carry, etc.), but rarely do you find information on the internal dynamics of the business and how things are evolving (or not).

 

This is why I found a recent article by venture capitalist Jeff Bussgang, titled “A Get Rich Slow Business” particularly interesting.  In the article, Jeff describes how an interesting set of events has led to the outcome that many VCs, some relatively senior, have not seen a single carry check.  Carried interest (or carry), is the primary incentive that VCs have in order to create a return for their investors (the limited partners).  This is usually structured as a percentage of the profits that the fund generates for it’s LPs.  The simple (and important) effect of carry, is that it aligns the interests of the LPs and the GPs (general partners) managing the fund.  If a fund makes a profit, VCs get a portion of that profit.  If the fund fails to make a profit, there’s no carry.

 

Clearly, we as entrepreneurs don’t have a lot of sympathy when it comes to the money that VCs make (with or without the carry), but it’s an interesting situation that might have other implications for entrepreneurs.

 

Jeff does a good job describing how this lack of carry might impact the VC industry in the sense that GPs might be more easily “poached” by competing firms.  The point is well taken, but what I’m really interested in is how this situation might impact the relationship between GPs and the entrepreneurs they work with.

 

Here are some of the questions I have:

 

  1. In theory, is it in an entrepreneur’s interest (all other things being equal) to raise funding from a fund that is likely to generate carry for it’s GPs?  My gut tells me yes, but this is based primarily on the fact that funds generating carry are usually successful funds.  It is almost always better to raise funding from a successful fund (if you can) than a not-so-successful one.

 

  1. If the GP that has funded your startup does indeed get “poached” and moves to a different firm, how does that impact your life as an entrepreneur?  My guess is that this would be a setback as a GP doing his or her job would likely have learned a fair amount about your business, its competition and its strategy.  A new GP is less likely to generate the same “value”.  

 

  1. If the venture firm is at the tail-end of its’ current fund (i.e. most of the capital has already been deployed), and the probability of a carry being generated is reasonably well known, are they likely to push the startup more or less to exit?

 

If there are entrepreneurs that have been impacted by this (either by raising a round from a fund that has had lack-luster success, or having their GP move to a different firm), would love to hear your comments?  On the other hand, even if you have good, plausible theories too, feel free to chime-in.

Posted by admin_halligantravel admin_halligantravel on Sat, Jan 27, 2007

COMMENTS

The whole idea behind VC is to start/buy a company, build it up and at it's peak sell to the highest bidder. The VC has to sell when the company is on the way up. If not, the VC will be stuck with a flat company and the ROI will take much longer thereby pissing off the partners. Or the VC will unload the company at a discount and suck as much cash out until it is unloaded or put into bankruptcy. And then some partners don't mind having losses that will offset other income.

Entrepreneur, beware those with funds:
"The man with the gold makes the rules"

posted on Wednesday, January 31, 2007 at 7:20 PM by Dale Hernlund


I hate to say this, but compared to the huge dialogue that your other posts have garnered, the relative dearth of comments here shows how many entrepreneurs actually care about VCs.. Or am I wrong?

posted on Sunday, February 11, 2007 at 6:24 AM by Shefaly


I recently bought 5 N Plus (VNP-TSX) a growth company in solar energy panels. It went up after the last report Thurs. 
 
 
 
Any opinion? 
 
John

posted on Friday, April 10, 2009 at 3:38 PM by john morgan


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