Fees, carried interest and reserves mean a venture fund's portfolio must earn a much higher gross multiple than the net multiple its investors receive. Working backwards shows what a fund needs from its best companies.
12 min read · Level 5
I find the gap between the gross and net multiple the most useful single fact for understanding a venture fund. Once you see that a 3x net target means more than 4x on the money actually invested, a fund's appetite for enormous outcomes stops looking like ambition and starts looking like arithmetic.
A simplified 100,000,000 venture fund:
Fees. 2% a year for ten years (ignoring step-downs):
Fees = 100,000,000 x 2% x 10 = 20,000,000 Investable capital = 80,000,000
Target. Investors want 3x net: 300,000,000 returned to them.
Carry. 20% of profit above the 100,000,000 committed. If gross proceeds are G:
Carry = 20% x (G - 100,000,000) Investors receive G - carry = 300,000,000 G - 0.2G + 20,000,000 = 300,000,000 0.8G = 280,000,000 G = 350,000,000
Check: carry = 20% x 250,000,000 = 50,000,000; investors receive 350,000,000 - 50,000,000 = 300,000,000.
Gross multiple on invested capital = 350,000,000 / 80,000,000 = 4.375x.
To deliver 3x to investors, the portfolio must return about 4.4 times the money actually invested.
Because it explains what venture funds must seek. A portfolio of solid 2x outcomes cannot deliver a 3x net return after fees and carry.
It also helps founders and co-investors understand why a fund pushes for very large exits, and helps prospective fund investors judge whether a fund's strategy can plausibly reach its target.
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Sources: Institutional Limited Partners Association; U.S. SEC - Private fund advisers; U.S. SEC - Investor.gov
What the best company must do.
Initial investments 40,000,000 (half of investable capital) Reserves for follow-ons 40,000,000 Initial cheque 1,600,000 each, in 25 companies Target ownership at exit 7% in the best company
Exit needed for one company to return the whole fund (100,000,000): 100,000,000 / 7% = about 1,428,600,000
Exit needed for one company to provide half of the 350,000,000 gross target: 175,000,000 / 7% = 2,500,000,000
With 25 companies, the fund likely needs at least one outcome in the billions, plus several strong ones, to reach its target.
Assuming a fund's portfolio needs to earn the same multiple its investors are promised, ignoring fees, carry and the capital that never gets invested.
Subtract total expected management fees from committed capital.
Decide the multiple investors should receive.
Add back carried interest on profit.
Divide by ownership at exit to find the exits the best companies need.
When evaluating a venture fund, or understanding the incentives of a fund investing in a company.
Do not rely on simplified calculations for real fund commitments; actual agreements include fee step-downs, hurdles, recycling and other terms that change the numbers.
Institutional investors and their advisers commonly analyse the difference between a fund's gross and net returns, since fees and carried interest can consume a large share of gross performance, and industry groups have pushed for standardised fee and expense reporting to make this visible.
The spread between gross and net returns is a core part of evaluating any fund.
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