UPDATE: Raising Capital: Why VCs Need Grand Slams
In regards to my posting on why VC's need grand slams, I'd like to point out two more interesting articles that help elucidate the process of VCs raising money.
Matt Marshall of Silicon Beat posted an article yesterday on RedPoint Ventures raising a new $400M fund. The article is an interesting look at why a firm with estimated fund IRRs of negative 18.5% and negative 7.9% has been able to raise more capital. The article also provides data on what carry fees look like and suggests that a 30% carry is reserved for the top 10 or so firms. Also there is another interesting data point in the comments that suggest 2.5% as a management fee to be a reasonable assumption.
A second informative article was written on Feb 20th by Bill Burnham. The article suggests hedge funds will encroach upon venture investing sooner rather than later. In making his argument Mr. Burnham provides more data about carry and management fees:
"The baseline fee structure in the industry is a 2% management fee and a 20% share of any profits (known as the carry). The best firms get a 3% fee and a 30% carry. A few rare birds do even better than that. While some firms split the profits equally between the partners, most skew the GP split to favor the more senior (though not necessarily the most successful) partners."The article also makes two other points that I found very interesting. Given the relative size of hedge funds as compared to venture funds (many billions vs. hundreds of millions), hedge funds can divert relatively small percentages of their capital under management and instantly become major players. Mr. Burnham also suggests hedge funds may not even after profits from their venture investments but rather information that they can use to place smarter bets in the public markets where they invest the majority of their capital.
Personally, I think that hedge funds will have a hard time getting into early-stage investing but they definitely could become a force in later-stage investing because it seems logical that mezzanine financing valuation techniques would be similar to the manner inwhich publicly traded stocks are priced.
Lastly, I want to point out a mistake that I made and will correct in my original posting. I wrote that based on John Nesheim's example in High Tech Startup, that the successful investments would have to return approximately 100x the money invested to cover the net losses on the unsuccessful investments. I found a mistake in my calculations and based Nesheim's example the successful investments would only have to create returns of 92X. I think my point of these numbers being way off still holds because they take into account venture firms that fail and I don't believe that successful venture firms have portfolios littered with 90% non-performing investments. Furthermore, Charlie O'Donnell who is an analyst with Union Square Ventures made an interesting comment suggesting that VC home run investments can be achieved at 4-8x returns.