13 ms·

I'm not. 2% of X * 10 years = 20% of X. The GP contribution is 5% of X. Net contribution is -15%, regardless of fund performance.

by SeoxyS 11y ago

chimeracoder 11y ago
I get what you're saying, and the VCs definitely do have a pretty sweet deal no matter how you cut it, but I still don't think it's fair to add those together directly. Ostensibly, the 2% management fee goes to the firm and is intended to cover operations, business expenses, and overhead, rather than individual compensation for the partners. On the other hand, the money they put in does come from them individually (and the carry goes back to them individually as well). They're not supposed to be using the management fee to compensate themselves personally in the way that -20% + 5% would imply. I won't pretend that there aren't partners and/or firms who abuse this, but that's not the way it's intended to work. And if they don't use that fee to cover all necessary operations first[0], it constitutes outright fraud and the LPs would sue. [0] And there are a lot of expenses - running a venture firm may be lucrative in the long run, but in the short run, it's expensive!
- foobarqux 11y ago
  Dollars are fungible and management fees aren't just for expenses, they are compensation for running the fund.
  - chimeracoder 11y ago
    > Dollars are fungible When there's no cost to moving them, yes, but that's not the case here: We're talking about the VCs personally, and the money that is in the hands of the firm is not worth the same to the VCs personally. Even if they could take the entire amount with impunity, they'd still be taxed on it as income, meaning that they'd lose as much as a third (depending on their marginal tax rate), so 15% is already incorrect from the start. But on top of that, they're not able to pocket all of that money, because they have a fiscal responsibility to use it in the interest of the fund's shareholders. The same is not true about their personal bank accounts (which is where the 5% comes from). Dollars are fungible, but that doesn't mean that $1 in a highly restricted fund is the same as $1 in an unrestricted fund. The former is worth some amount less (the discount determined by the premium associated with the restriction). If that last paragraph weren't true, by the way, money laundering schemes wouldn't lose any money due to attrition, and corruption would be essentially "free". But thankfully, that's not the case - people who embezzle money have less than 100% yield. (Not always a lot less, but still less). > management fees aren't just for expenses If LPs can show that a VC is neglecting necessary expenses and instead pocketing the management fee - as 5%-20% = -15% would imply - then the VC had better figure out how he's going to pay his lawyers, because the LPs have got a great lawsuit on their hands.
    - foobarqux 11y ago
      > If LPs can show that a VC is neglecting necessary expenses I didn't say that they were neglecting expenses, only that they spent some of the management fee on things that were not expenses. > fiscal responsibility to use it in the interest of the fund's shareholders I don't think that's true but it's easy to argue that the transaction is in the interests of LPs. > they could take the entire amount with impunity, they'd still be taxed on it as income I suspect, like private equity firms, they net the transactions or use some other tricks to avoid taxes. So I could offer you a rebate on management expenses and in return get 5% of the fund.
charlesdm 11y ago
I don't think that's a great example. 1/ If the lifetime of a fund is 10 years, partners don't get the management fee for ten years. They get the fee until the fund is fully invested (usually 5-6 years). 2/ Money in is capital, money out is taxable income (unless it's carry, then it's a repayment of capital/capital gains). If the fund returns nothing, you lose your capital. This creates following situation: 1/ 2% * 5 years is 10%, meaning as a partner you make 5% (probably a lot less, since you need to deduct expenses). 2/ Once we take into account taxes (let's say ~25% on $x), you are not making much, because your 10% becomes 7.5% after taxes. But GPs can't invest 5% in a fund of a few billion $/€. Then again, you can't raise that kind of money without a track record, so maybe it doesn't matter.
- foobarqux 11y ago
  The portion of management fees set aside to invest in the fund probably aren't taxed because they most likely rebate the management fees in exchange for equity in the fund.
  - robk 11y ago
    Generally, no.

I'm not. 2% of X * 10 years = 20% of X. The GP contribution is 5% of X. Net contribution is -15%, regardless of fund performance.

by SeoxyS 11y ago

I'm not. 2% of X * 10 years = 20% of X. The GP contribution is 5% of X. Net contribution is -15%, regardless of fund performance.

chimeracoder 11y ago

I get what you're saying, and the VCs definitely do have a pretty sweet deal no matter how you cut it, but I still don't think it's fair to add those together directly. Ostensibly, the 2% management fee goes to the firm and is intended to cover operations, business expenses, and overhead, rather than individual compensation for the partners. On the other hand, the money they put in does come from them individually (and the carry goes back to them individually as well). They're not supposed to be using the management fee to compensate themselves personally in the way that -20% + 5% would imply. I won't pretend that there aren't partners and/or firms who abuse this, but that's not the way it's intended to work. And if they don't use that fee to cover all necessary operations first[0], it constitutes outright fraud and the LPs would sue. [0] And there are a lot of expenses - running a venture firm may be lucrative in the long run, but in the short run, it's expensive!

foobarqux 11y ago
Dollars are fungible and management fees aren't just for expenses, they are compensation for running the fund.
- chimeracoder 11y ago
  > Dollars are fungible When there's no cost to moving them, yes, but that's not the case here: We're talking about the VCs personally, and the money that is in the hands of the firm is not worth the same to the VCs personally. Even if they could take the entire amount with impunity, they'd still be taxed on it as income, meaning that they'd lose as much as a third (depending on their marginal tax rate), so 15% is already incorrect from the start. But on top of that, they're not able to pocket all of that money, because they have a fiscal responsibility to use it in the interest of the fund's shareholders. The same is not true about their personal bank accounts (which is where the 5% comes from). Dollars are fungible, but that doesn't mean that $1 in a highly restricted fund is the same as $1 in an unrestricted fund. The former is worth some amount less (the discount determined by the premium associated with the restriction). If that last paragraph weren't true, by the way, money laundering schemes wouldn't lose any money due to attrition, and corruption would be essentially "free". But thankfully, that's not the case - people who embezzle money have less than 100% yield. (Not always a lot less, but still less). > management fees aren't just for expenses If LPs can show that a VC is neglecting necessary expenses and instead pocketing the management fee - as 5%-20% = -15% would imply - then the VC had better figure out how he's going to pay his lawyers, because the LPs have got a great lawsuit on their hands.
  - foobarqux 11y ago
    > If LPs can show that a VC is neglecting necessary expenses I didn't say that they were neglecting expenses, only that they spent some of the management fee on things that were not expenses. > fiscal responsibility to use it in the interest of the fund's shareholders I don't think that's true but it's easy to argue that the transaction is in the interests of LPs. > they could take the entire amount with impunity, they'd still be taxed on it as income I suspect, like private equity firms, they net the transactions or use some other tricks to avoid taxes. So I could offer you a rebate on management expenses and in return get 5% of the fund.

charlesdm 11y ago

I don't think that's a great example. 1/ If the lifetime of a fund is 10 years, partners don't get the management fee for ten years. They get the fee until the fund is fully invested (usually 5-6 years). 2/ Money in is capital, money out is taxable income (unless it's carry, then it's a repayment of capital/capital gains). If the fund returns nothing, you lose your capital. This creates following situation: 1/ 2% * 5 years is 10%, meaning as a partner you make 5% (probably a lot less, since you need to deduct expenses). 2/ Once we take into account taxes (let's say ~25% on $x), you are not making much, because your 10% becomes 7.5% after taxes. But GPs can't invest 5% in a fund of a few billion $/€. Then again, you can't raise that kind of money without a track record, so maybe it doesn't matter.

foobarqux 11y ago
The portion of management fees set aside to invest in the fund probably aren't taxed because they most likely rebate the management fees in exchange for equity in the fund.
- robk 11y ago
  Generally, no.