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When an investor (also known as a limited partner or "LP") invests in a venture fund, they’re buying a service. And just like any service, it costs money.
The LP is paying the fund manager (known as the general partner or "GP") to invest their money. This means they’re buying access to the GP’s dealflow, expertise, and relationships.
If the GP is a good steward of their investors’ money, fees their LPs pay will be minor relative to their returns. But if the GP makes poor investment decisions, those fees only add to the LPs' losses.
That’s why it’s important for LPs to understand the fees associated with a fund before investing—just as it’s important for GPs to create a reasonable fee structure that won’t deter LPs from investing in their fund.
In this guide, we’ll look at the typical fees associated with venture capital funds and how investors can calculate the fees associated with an investment in a fund.
LPs generally pay three categories of fees when investing in a venture fund: (i) fund expenses for organizing the fund and ongoing fund administration and legal fees, (ii) fund management fees, and (iii) carried interest. Let’s break down each one.
Before the GP can start accepting money from LPs, they need to create a legal structure for the fund. A fund or SPV (special purpose vehicle—a fund designed to invest in one specific company) is typically structured as a limited partnership, in which the LP provides capital for the investment and the GP uses the funds in accordance with a partnership agreement.
Filing fees to register a limited partnership can cost anywhere from $500 to $2.5k annually. Then there are attorney fees to set up the fund, which can typically cost several thousand to tens of thousands of dollars depending on the complexity of the fund.
Once the fund is up and running, a GP is likely to pay ongoing legal fees related to side letter negotiations, amendments to the fund’s operative documents, and other expenses that require legal expertise. Additional fund administrative fees typically include the preparation of financial statements as well as annual tax preparation services.
Note that fund formation and administration fees are typically fund expenses that are paid by the fund and allocated on a pro rata basis to fund LPs.
A fund management fee is an annual fee paid by the fund to the GP to compensate the GP for their work and to cover certain expenses related to operating the fund such as salaries, insurance, and travel. A management fee usually ranges from 2% to 2.5% of committed capital and is usually charged every year the fund is in operation.
Like fund administration fees, fund management fees are a fund expense that is allocated to LPs on a pro rata basis. The fund management fee is defined in the fund’s partnership agreement.
Management fees can be paid on a straight line basis over the fund’s life or be paid on a “step-down” basis in which a GP reduces management fees after a certain number of years or at the completion of a milestone (for example, when all investments are made). At the point of step-down, the GP might change the management fee structure to only 2% of invested capital, rather than 2% of committed capital, reflecting the reduced workload of the GP after investments have been sourced.
The size of the management fee often depends on the size of the fund. Seed funds sometimes charge higher management fees than later-stage funds because they have less capital commitments, and therefore may look for a proportionally larger fee to cover ongoing expenses. A $15M fund with a 2% management fee would collect $300k annually to cover day-to-day operations. If that fund had a 10-year lifespan, LPs would pay $3M over the life of the fund.
Management fees typically cease when the fund terminates (which usually happens contractually after 10 years) or when all of a fund’s investments have exited and final distributions are made. A fund might also cap the amount of management fees it collects at a certain amount.
While it’s normal for a GP to draw a modest salary from management fees, a fund manager’s primary incentive should be the carried interest they can earn on successful investments.
It’s also important to know how much “skin in the game” (i.e., their own capital invested directly into the fund) the GP has. If a GP has invested a decent sum of their own capital, it helps show they’re committed to the success of the fund. If not, LPs may question their motivations.
On AngelList, GPs generally charge a 2% annual management fee on Traditional Funds and Rolling Funds. Management fees accrue over the first 10 years of the fund’s life. GPs can also waive management fees on an individual basis (so that not every LP has to pay the same fee). This privilege is usually reserved for major investors or friends and family.
Carried interest is the percentage of profits that go to the GP of a fund. You’ll often hear the term “two and twenty” to describe funds because many charge a 2% management fee and 20% carried interest. On AngelList, carried interest is typically 20% of profits, although it can vary depending on a GP’s track record and management fee.
If a fund has a carried interest rate of 20%, it means the GP will receive 20% of the profits from any investment after the principal is returned to the LPs. The other 80% gets distributed to LPs. So if a GP charges high fees, they must generate higher returns to see their full carried interest.
If cary is paid on a deal by deal basis, LPs often demand a “clawback provision” be included in the fund. This is when carry paid to a GP on a deal-by-deal basis is “clawed back” by LPs if later investments fail to meet a certain return. The money clawed back allows LPs to recoup a portion of their losses.
To learn more, read our guide to carried interest.
Let’s say I want to raise a fund to invest in a series of climate tech startups with a 2% management fee and 20% carried interest. For the sake of simplicity, I’ll raise $5M from a pool of 25 investors (including myself), with each investor putting in $200k. I used AngelList to form my fund, which means the fund is charged a 1% admin fee annually, capped at $25k. Because each investor invested the same amount, the fund administration fee is allocated evenly amongst all of my investors ($1k each per year, paid by the fund).
My management fee is 2% of committed capital, or $100k annually (2% x $5M = $100k). This is again allocated evenly among investors as a fund expense. This means they are allocated $4k of the fund management fee expense annually on top of the $1k in annual admin fee allocations. These fees are paid by the fund out of the capital contributed by LPs (LPs don’t pay these fees directly).
After Year 4, a portfolio company gets acquired for $2.5M. All of the proceeds are returned to LPs on a prorated basis—meaning each LP gets $100k back.
At Year 6 there’s another $3M distribution, making the total distributions to date $5.5M. The $3M distribution means each LP receives an additional $116k: the first $100k is a return on their remaining $100k capital contribution, and the remaining $16k is equal to 80% of the additional $20k (the $4k is allocated to the GP as their 20% carry).
GPs choose their own fee structures, but LPs can often negotiate a rate they feel comfortable with. Relevant questions for an LP to answer in thinking about management fee levels include:
Understanding the fees associated with venture capital will help LPs pick the right fund and provide a realistic expectation of potential returns.
To learn more about management fees on AngelList, visit our Help Center.