There are 3 rough strategies:
- Maximize returns.
- Maximize fees.
- Stay Alive.
VC is tough. Only the top 25% of VC firms even double the capital they are given (2x), and that’s not really good enough results for the LPs.
However, a small % of firms do Crazy Well. 8x-10x well.
If you believe you can do 8x-10x, you’re in it for the “returns”. The salary you take, the money you put in, are sort of irrelevant if you can turn $250m into $2.5 billion. There, the partners keep 20% (or more), so share $450m in returns. In just one fund.
But this is very rare. The Uber-Snap-WeWork Benchmark fund, The Uber Menlo Fund, the Facebook Accel fund can do this. But otherwise, it’s very hard except for a very small fund.
If you are struggling to do even 2x (as most funds are), the logical path instead is to optimize around fees.
Here, you want to raise the largest fund you can sort of get away with, and put in the least amount you can. 2% fees on a $200m fund is still $4m in fees a year, with no obligation to do anything other than pay those fees to yourself. And if you can raise say 3 funds, those fees partially stack up on top of each other over the 10-year lifespan of the funds.
Finally, some funds are just hoping to Stay Alive. Hoping one of their investments finally “hits” and they can live to raise another fund.
The incentives create different behaviors:
- Maximize Return funds swing for the fences, often on seemingly crazy deals at crazy prices, and lose big, but also try to win big. If you are say Sequoia, it is sort of OK to lose $25m on a deal this week if you just returned $500m on another deal last week. Not really OK, but sort of OK.
- Maximize Fee funds want to do well, but want to mitigate the downside risk more. The checks are smaller, the traction bar often higher. The key is to do well enough on paper to raise the next fund. Here, one IPO usually is enough to maintain momentum. One IPO usually returns enough capital to get Another Check from the LPs.
- Stay Alive funds tend to be hyper-focused on their portfolio. They often don’t have much new cash left to invest, and they can smother their investments like helicopter parents. Sometimes, they tend to panic over small stuff.