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Jon Bradshaw & Peter Harris

This is one episode you shouldn't miss out. Do tell us what other stereotypes you have when it comes to VCs?

How Do VCs Make Money

How do VCs Make Money?

Some of you might be intrigued to understand how a VC fund runs. How do they make their money? Peter breaks down all that in this episode and all clear out the air if VCs are rich.

Questions Covered in This Episode Include:

  1. Peter, everyone wants to know how VCs make money? ( Carried interest and management fee)
  2. How important is it to be rich to be a Venture Capitalist?
  3. What is the average salary of a VC? (Partner/Analyst)
  4. Sometimes people criticise venture capitalists because they get rich off of management fees and not fund performance 
  5. Does deal performance that you lead affect individual compensation?
  6. Are they overpaid?
  7. How does the compensation structure affect how you make invest decisions
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Episode Transcript

Peter: All right. Welcome, everybody, to the Venture Capital podcast. So today we're going to talk about how VCs make money, because I think this is something that the you know, not a lot of people know. They everybody thinks like VCs are like super rich, which is often the case, but not always. Okay. You've ever wondered about this, Jon?
Jon: I think I've got an idea. I've got a pretty good idea.
Peter: Yeah. What do you think? Most VCs, rich are not rich.
Jon: Yes, I think most VCs are rich.
Peter: Do you think most VCs that I like because they're VCs or because they did something else?
Jon: But I think they were rich before they became a VC.
Peter: Okay, so it's like the rich getting richer. Or is it the rich just staying rich, or is the rich getting poorer?
Jon: I think it's a combination. I think people who enter go into VC. It's kind of a natural ladder escalation. So I might have done a really well my professional career. I want to make a change. I think a lot of people who become partners at funds typically go to newer funds. And if you're able to put in a million, 2 million in cash, I feel like they kind of by themselves a job.
Peter: Okay. And then that's an interesting perspective.
Jon: And then once they're in.
Peter: Yeah.
Jon: Then they can rise. Now you've got other people like. What is it like Ethan Choi. Is that a name you enjoy?
Peter: Yeah, he is Excel.
Jon: He's over the Excel. I forget where he was previously at, but I don't think he had a lot of funds. I think he was just amazing.
Peter: And yeah, they're not straight.
Jon: We'll comment below where he was at. But I mean, he was a BYU student. He got his MBA. He went from One Fund to Excel, and I think it was solely just because he's got a brilliant mind and he's very talented for the space. And so I think he would be an outlier. But I think most I think most people get into VC by saying, Hey, here's $1,000,000 check.
Jon: I'm going to invest, make me a partner, and let's let's get started.
Peter: That's fair. I don't know if that's entirely accurate, but not entirely accurate. It's an interesting perspective, especially from somebody that's a little more outside.
Jon: Okay.
Peter: So VCs make money two ways. We've talked about this on other episodes. I mean, basically you get compensated with management fee and carried interest. So if you make if you have $100 million fund every year, you're going to draw 2% of that as management fee, and that's to pay salaries. So that's 2 million bucks every year coming into the management company.
Peter: Now that's got to cover a lot of expenses. It's got to cover your overhead, right? Your office, your you've got to pay your admins, your analysts, everybody. Right. So 2 million sounds like a lot, but then when you start giving it up, you know, it can go away pretty quick. And then you get Kerry and the Kerry you only get once you've paid back on the management fee.
Peter: So if somebody you have $100 million fund and you make a bunch, you're going to draw about 20 million, 15 to $20 million of that and management fee. That means that that leaves you with 80 to $85 million if you don't recycle. And recycling is just means that you're taking the profits of some of your investments that have been successful and you're reinvesting them in new companies.
Peter: So you invest 80 to $85 million. And if like those all fail or you don't return the whole 85 million, like you're not going to get any. Kerry Even if like one deal is like really successful, if all the rest aren't, it's going to drag it down. You won't get any any. KERRY But if it is successful and you take that 85 and you turn it into like, I don't know, and averages are like 3 to 5 x the fund, so you turn it into 300 to $500 million, then you're going to return the hundred million that you invested and you know, and the fees that you drew and then anything over that, you'll typically
Peter: split 8020. So, you know, if it's $300 million, that's 200 million of profit and you're going to pocket 40 million of that in carried interest. And your investors look at the other 160. So but this is how that's how they make this is.
Jon: How a fund makes money.
Peter: It's how funds make money.
Jon: How much money does a VC make?
Peter: But then the individual. V.C. Yeah. So so then you got to ask a question like how much money? Like how big is the fund, how much money is Let's just.
Jon: Say it's $100 million fine.
Peter: Yeah. So and then you got to ask, like, what's the strategy of the fund? So if you're a $100 million fund, you're probably which is about this day and age. It could be like seed series, a fund.
Jon: But it's an average 100 million would be an average fund size or.
Peter: A lot depends on what you're what stage you're investing it. I would say.
Jon: Anything across the board for like across the board of.
Peter: All funds.
Jon: Not all funds, just VC funds of.
Peter: All venture funds.
Jon: And let's exclude seed because seed might be a very unique category for a you know, for a series eight.
Peter: For series A, I mean, probably your average fund is like 150 to 200 million would be my guess. Okay, somewhere in that range.
Jon: Okay.
Peter: On average. But you know, it skews right like Andrew since closing like billion dollar funds and then you've got other people that's their first time fund and they scrape together half a million bucks. So it's a pretty big delta. Okay. But anyways, okay, so point being, let's say you have a $100 million fund, you probably have call it three partners.
Jon: Yeah.
Peter: Three partners, two associates, analysts and then like some a couple of admin staff, maybe like one admin to admit it. It kind of depends like if you're using somebody else to do all your fund admin or if you have somebody in-house. So that's 2 million bucks. That's got to be split. So you've got, you know, three partners. You know, they're probably each making like 300 grand, you know, 300 or 400 grand somewhere in there.
Peter: So that's 1,000,001.2 off the top for the partners. And then your analysts are probably making somewhere between 75 and 150, depending on their experience and so forth.
Jon: This is per.
Peter: Year. Per year. Okay. And then you've got your admin and you've got your other operating expenses, but.
Jon: Your other.
Peter: Operating expenses are probably another half million.
Jon: Bucks. So you're seeing a partner is making a million a year.
Peter: No, no, no. Like 3 to 400 grand a year. Okay. After this, like imaginary fund.
Jon: Of 100 million, 100.
Peter: Million, 100 million bucks, three partners each making 300 grand. Okay, I'll just say so. I put it at 900,000, and then you've got your couple of analysts, associates, maybe that's another 200,000 to cover their salaries. So now you're at 1.1 and then you have your admin. Maybe that's another hundred grand. So I want to. then you've got your like operations or travel office expense, blah, blah, blah, like food, whatever.
Peter: That's probably like a half million bucks. If you're if you're running around the country looking at deals, then that leaves you with what, 300 grand? So yeah, then you top up the partners another hundred grand. So yeah, that's probably pretty typical. So around that range, the average.
Jon: Partner is making 300 K.
Peter: Yeah, well I don't know, that's just that, that's how I would expect roughly like $100 million fund to operate. So they're making like, yeah, like three or 400 grand. Then you start, then you start stacking funds. So that's.
Jon: What I want to ask.
Peter: About. Every, every 3 to 5 years you're going to raise a new fund. So I'd say it's $100 million for the first fund. Well, then the second fund, you're going to also be drawing 2 million bucks.
Jon: So instead of making the guideline 600 K that.
Peter: Year, Yeah, you're making 600 K, And then I would like a third fund. But what happens is by the time you get to the third fund, the fourth one starts tapering off in the first fund. So you're not making as much money on that one. And the fund two is also maybe starting to dip a little bit. So yeah, my guess is that most partners, like in a steady state like successful fund where they're like raising subsequent funds, they're making good investments, generating good returns.
Peter: Like their salaries probably range anywhere from like 200 to 5 or 600,000 a year.
Jon: Okay.
Peter: For the partner level and for the analysts associates, they're probably closer to like 100 grand on average, some above and below. admins are probably below that.
Jon: Okay. Are they making for both these groups? What percentage of their salary is management fee versus carry? I mean, they're total like total comp.
Peter: Yeah. So every firm's a little bit different, but a lot of them only partners get carry.
Jon: So analysts wouldn't function. Yeah. Okay.
Peter: So in funds like the thing you have to keep in mind is that like there's a bifurcation and there's really like three types of jobs and we kind of mentioned them, right? One is basically it's like partner, partner, track, and then there's like non partner track.
Jon: Account.
Peter: From an investment perspective and then there's admin, right? And admin could be secretaries, office managers, CFOs, accountants, marketing recruiters like all of that other stuff that's not related to making investments and they're just going to get paid similar to like whatever the comparables are for the market. So like if you're a secretary, you're going to get paid similar to what another secretary you get paid and it'll be salary.
Peter: Okay, like a bonus to earn associate, you're going to get paid. Like I said, like a lot of those are if they've done investment banking, they'll maybe maybe make like over 100 grand. If they haven't done investment banking, they probably make less than a hundred grand. So just kind of varies. They typically don't get any carry. they don't have like fiduciary responsibility.
Peter: So that's like they're not like legally on the hook for the investment decisions that they make, which is also partly why they don't get Kerry.
Jon: Who decides the salary of a partner at.
Peter: A fund. So it's a negotiation.
Jon: With a negotiator helps.
Peter: The partner usually with the other partners. Yeah. Okay. Yeah. Usually the LPs are like, hey, you know, we're paying. If you guys.
Jon: Get let's say a VC salary is 300 K If they came from industry, do you think that would be Did they step up to 300 K or do they drop down to 300 K from their prior salary? Do most people take a pay cut, especially on the first time in.
Peter: Usually like on a first fund? Yeah, they're probably taking a little bit of a pay cut. Okay. Broadly speaking, not always, but broadly speaking.
Jon: Okay. Now I think one of the.
Peter: Because they're also if they're a partner, they're also going to make money on the Kerry side. Theoretically.
Jon: Okay. Now, this is a big critique. I've been told by a friend whose husband worked at the Mayfield Fund in San Francisco that most of the venture capitalists make their returns off of management fees and not off of Kerry, which is one of the big secrets. So, again, like you're you know.
Peter: I'm just getting rich off management fees, not for another for Kerry, but everybody's like, hey, we're going to get rich off of Kerry. Like we're perfectly aligned with our investors, right? So, yeah, it's a very it's a it's a big criticism, especially as the fund gets bigger and bigger and bigger. Like, think about it this way. Like, yeah, $100 million, you're pulling in $20 million of management fee, but like you add a zero and that you're managing $1,000,000,000, which used to be unheard of.
Peter: But now there's lots of funds that manage a billion in one fund, let alone like multiple funds. Right? Because you could have fund stack like $300 million fund, you know, three times in that stacking. So all of a sudden now you've gone from $2 million to $20 million, right. To a management fee annually. And you may not have that many more partners.
Peter: Right. So yeah, so a lot of these these these VCs can pocket a lot of money over the years and it's like fairly stable because like it's ten years. So every year for ten years, like there's a management fee getting paid. And if investors stop paying the management fee, the limited partnership agreements, the industry standard is basically like they lose their investments.
Peter: So they're highly incentivized to continue to pay in and cover those those management fees. So yeah, so it's it's a big critique. And then as an investor, it's kind of like, well, it's ten years. Like I can just kind of sit back and like maybe in ten years I'll have pocketed I mean, think about it this way. Let's say you have a $300 million fund, three partners.
Peter: You're going to be pulling like a million a year roughly in salary. So then it's like, for ten years, I'll just, you know, save a lot of that and then I'll retire with, you know, 7 million in the bank and call it good, right? And who cares if my investments perform or don't perform. Now, if they don't perform, I won't be able to raise another fund.
Peter: But like, what do I care? I've just pocketed a whole bunch of money. So yeah, it is a critique. And then you add on top of that, like venture is hard and most funds fail. And so like I was talking to a banker who works with a ton of venture funds and he like banks, venture funds, and he was like, he's like most of the VCs I know have never they've never gotten a Kerry check.
Jon: Really.
Peter: Like ten years in or whatever it is. They've never gotten a Kerry check because what happens is they make a bunch of investments, those investments, they invest early and those investments raise subsequent rounds. And so valuation goes up. So on paper, like it looks like they're doing great, they go out and they raise a bigger fund, Right. And they do it again.
Peter: And like Fund, who's investments start looking great fund one like given enough time, like some of them like start to crater right? But like they get fund two raised and then like now you're on to fund three, maybe you even get fund three closed, but then fund one ends up like all the investments start tanking and dying and like the fund ends up basically just returning the money that it had invested and doesn't end up generating any carry for its partners.
Peter: But now we're like nine years into it, right? Because these funds are ten year funds. So you invest the first three years and then you're harvesting the last seven. And like some of those, like they take like 15 years to fully realize. So like, you're in it and you're in year nine and your investments are just you finally like paid back the fund, but you don't have any more investments still sitting in the portfolio, so you don't get a carry check.
Peter: But during that time period, you've raised three funds, you're PON security, you're following like 600 or $1,000,000 a year in fee, right? Like and you know that you've got at least another seven years of income coming in, right? Yeah. So that's a criticism and it's like it's a legit criticism of like, hey, you know, our VCs really incentivize.
Peter: Now, the flip side is the VCs that are really good. They make most of their money and.
Jon: Kerry Okay, so but you have to be in the Spotify, the Uber, the Lyft, like there's very few deals that proper for that perform that well and lucid.
Peter: Sure. But if you're in, I'm like, you're set, right? It's like the guy that invested in Snowflake and like the seed round. Okay, Like that guy, you know, depending on where he sold and like, how much he got and all of those things. But like.
Jon: Are you still riding the wave? And I don't.
Peter: Know. I don't know, like his his personal situation. But like, you run the numbers an estimate like he might have pocketed $1,000,000,000.
Jon: Off of how big of a.
Peter: Check for that like one deal it was like you know like a million bucks it like you know, in the seed round or something or half a million. Who knows what it was. But like, like that's that's pretty crazy.
Jon: So like, let's say there's a let's say you guys find the next snowflake, you put an half million dollar check, you're leading, you've led that deal sells for $1,000,000,000. Does the fact that you lead let it affect your compensation and how you make money as a VC?
Peter: Yeah, it's a good question. And the truth is it really comes down to the structure of the fund. Okay. So if you agreed with your partners, like, Hey, on deals that I lead, I should get like a bigger, I should get a lion's share of the carry off of that deal. Like, that could be the case, right? It could be cases like I know certain situations where the V.C. generated, you know, 90% of the returns and he's only walking away with 5% of the carry.
Jon: Okay.
Peter: What what's sometimes that happens what's common, though? But that's their structure, Right?
Jon: What's common, though?
Peter: I think the common thing is probably like whatever your deal is, that's the deal you get. So like, whatever you negotiate the beginning, like, okay, you get this much of the carry, Like that's how much of the carry you're going to get. Now, every fund.
Jon: Can change.
Peter: Could change, right? And we talked about like how for how to raise a fund. And in that episode we talked about like how funds are structured. So go back and listen to that one if you haven't yet. But but each fund you can view as like a new startup in a lot of ways. And so, you know, that same individual is going to go back to his partners and be like, Hey guys, like I'm only getting 5%, but like, look at the returns I generated.
Peter: You got to bump me up. If you want to keep me around and how me generate those kind of returns on the next fund.
Jon: What's what, what's general for a fund is that you're sharing that kind of like, equally. Or you're just saying, Hey, if you bring in a deal, you're going to get a higher percentage of that deal compared to everything.
Peter: I think the most common is like you're either equal or you get like a set percentage and that's that.
Jon: Okay. How does yes, how does compensation affect how you make investment decisions?
Peter: Yeah. So I mean, we've kind of touched on that already, right? So if you connect the dots, right, if if you're making a bunch of money off a management fee, you know, you're probably like not like maybe you're not working super hard because you're not as hungry. So that could be part of. Yeah, right. You're not hustlin as much as you could be.
Peter: Like, I'm going to sit on the beach. Another thing is like, I know some VCs, they look at it as like, Hey, my job, like $100 million fund or whatever, there's three of us. My job is to invest 30 million bucks. I'm going to reserve a dollar for every dollar I invest for follow on investment rounds. So I got to invest 15 million over the next three years.
Peter: That's 5 million per year. That's like one deal per year for a series, a fund. And we write $5 million series paychecks. So I got to do one deal a year and they will do that one deal, and then they're on the beach for the rest of the year.
Jon: Okay, I like.
Peter: Straight up right. Because they get they're making enough money on management fee. They can do that. Right. You got on the other end of the spectrum, you've got other VCs that are like, now like like I'm going to hustle every day. We're going to deploy the money. I'm going to look at tons and tons of deals. I'm going to be super supportive and help my portfolio companies and do everything I can.
Peter: And they work incredibly hard, right? So and so, yeah, some of the some of the people I know that work the absolute hardest are VCs and some of the people I know that like work the least relative to their compensation are also VCs.
Jon: Okay, awesome. Well, is there anything else we should know about how a VC makes their money? I think we've covered it pretty well, but.
Peter: What do you think? Do you think at the end of like describing this, like, do you think VCs are overpaid?
Jon: I think the market sets the price. In order to raise a fund, you have to have a certain amount of credibility. So I would say they're not overpaid. Yeah, but I do wonder if the market will, will, will shift. I think with social capital, I think they change how they they structured their deals and they're trying to I mean, I don't quote me on this, but my understanding is they're going more towards.
Peter: You know, you're on a podcast, I know.
Jon: I'm on a podcast, you don't call me and.
Peter: You are.
Jon: Literally But I mean, if I were to create a fund today and maybe this is my mentality is I would want to go big. So I would want as small of a management fee as possible. I wouldn't want I right funds to make sure you could make good decisions. Yeah, but I feel like a lot of these partners are don't necessarily need a salary or they need a limited salary.
Jon: And I would want to go big and I would want the high reward at the end of the day, not a management fee, but and I think but again, I mean, I don't know.
Peter: I would say the challenge you've got to wait ten years the Santos's for that that big payday right. It's a long time right.
Jon: So you know you got to figure that out.
Peter: Yeah that's fair. So you kind of do feel like they're overpaid in terms of salary, but not necessarily in carry.
Jon: no, I would If it were me, I would want more carry.
Peter: Yeah, but I'm more than 20% carry. You be like I deserve 50% carry.
Jon: No, but you don't know.
Peter: What you're thinking is like hey I would forgo that magic 2% like give me like half a percent and but then I want 25% carrier, 30% carry.
Jon: I mean, I don't know how I would I'm not in the reselling land and I haven't looked at it.
Peter: But I know it's crazy that like there are some funds like like really good funds they charge more than 2%. They charge like 3% and 30% carry. It's crazy. But the thing is, they can do that because their overall returns are like good consecutively, so that an investor that's investing in that fund will make more money than one that they with lower fees.
Jon: But I mean, ultimately what you care about as an investor is not the management fee. You care about your returns. Yeah, total return. So like a fund could say, hey, we take 50% management fees. Yeah, but are your returns are B you know.
Peter: But I would be concerned as an investor in a fund if like I felt like the investors were just getting like fat and happy for my management fees and not being like aligned with me to generate great returns on the fund because again, these are like ten year things and like, you know, like that's a long time for me as an investor, get my money back.
Jon: Yeah, I mean, I think the bigger concern for me is just fee stacking, right?
Peter: Yeah.
Jon: And that's how a lot of them make funds. So there's a lot Jeff Bermingham can see that you may have to believe that out. I mean the way I look at his model right now and how he's making most of his wealth is he did really well with real estate funds. So then he went and started PE Capital.
Jon: Was that peak signal peak ventures. And then so he's got his real estate management fees. He started getting VC management fees.
Peter: Yeah.
Jon: And the way I mean and that's and were I mean if he's doing a good job and he's providing returns and other people want to follow on at that point is hey how do I how can I raise more funds quickly? And as long as he's doing a good job, does it really matter?
Peter: As long as he's generating returns for investors, that's fine. Right?
Jon: And so however he structured it.
Peter: But the problem, like I said earlier, is sometimes it's hard to know if those returns are real because they're paper gains.
Jon: They're Mike marking up their IRR. Yeah, well, how do you guys mark up your how do you guys decide to mark up your returns?
Peter: We mark to market. So you know, we've got companies that are absolutely crushing it. Okay doing incredibly well we haven't written them up at all.
Jon: But what happens if you run into.
Peter: Other funds that don't do that? Other funds will like do like a whole DCF number, like and they'll run comps and then they'll try to justify like, hey, we made this investment.
Jon: But what is market with the end.
Peter: Of it in a year or two? And like.
Jon: So you're just saying, well.
Peter: Most funds do.
Jon: That. You're saying when someone makes their next investment is market and that's where you're just pegging it. Yep. Because on what was it on the Jason Calacanis podcast. Yeah, he was talking about a lot of these younger funds. They want to raise their next fund. Yeah. So all these companies right now are coming to the company and say, Here's our new valuation.
Jon: So they're finding a reason to mark that market up. And if there's a recession, it's going to crash and they're not going to be able to raise their second fund or kind of the markdown.
Peter: Could be ultimately mark to market, it's going to end up crashing if if if you're not doing mark to market because like auditors, especially if your fund is audited, if you're looking at investing in fund, highly recommended, like you invest in funds that the audit that get audit because kind of keep them honest. Yeah I mean like if you're like hey revenue doubled last year therefore like the valuation has doubled even if they haven't raised more money like that can get you in trouble.
Peter: If like, yeah, then we hit a recession and like all of a sudden off the mark, everything. Yeah, you could double 100% year over year, but that doesn't mean your valuation double really means your valuation went up by 50%. Now you've got to write down that investment. Okay. Which is awkward. Sure. So anyways, point being, I think.
Jon: Yeah. What do you think you ask me about? What do you think are VCs overpaid?
Peter: I think that some VCs are overpaid and I think some are accurate, appropriately compensated. But given the fact that most venture funds fail, I tendency is to believe in general that, like VCs are kind of overpaid. Okay, but not at university growth rank because we crush it.
Jon: Perfect. And you've got so you've got a nice bunch of logos.
Peter: Like our strategy is different than a lot of funds too. Like we don't we're investing in like very solid growth stage businesses where our loss, our risk of like losing our entire investment is relatively low. And so, you know, look, we're never going to be like a ten X fund, like some funds will that are swinging for the fences, you know, But the flip side is like we have a high degree of confidence that we are going to generate a very nice return for our investors, on a consistent basis.
Peter: And so far that's, that's what's panned out. So.
Jon: All right. Well, thanks for watching. Make sure you subscribe and interpret any comments below. If you're watching on YouTube so we can better answer questions that you have in upcoming podcasts.
Peter: And what do you think? Our VC is overpaid?
Jon: Let us know. Comment below. All right. Thanks, guys.