PEHub has a fascinating story about how you could radically remake the VC industry by replacing the current fund structure with a system of allocating funds to individual VCs:
Venture capitalists are a lot like professional athletes. They often work in teams, but are largely judged on their individual statistics. A great VC can be part of a lousy fund, because his successful deals get drowned out by the aggregate performance of mediocre partners. To keep the analogy going, think Paul Pierce on the ’06-’07 Celtics.
But what if you could have changed the ’06-’07 NBA from team vs. team to one-on-one? Wouldn’t Pierce have become far more successful?
That’s kind of the idea here. This proposal would have an experienced institutional LP (likely a fund-of-funds), create a series of loosely-affiliated evergreen “funds,” with each fund to contain just a single VC. In other words, cherrypick the cream of the crop. Give the VC an annual salary of around $1 million, an assistant, an associate and 15% of any carry. Perhaps a three-year contract, with a two-year LP option.
If the VC’s investments are successful, both he and the LP would make more money than had they both been working under the traditional structure. If the VC’s investments fail, then the LP presumably would lose less money than had it invested in a failed fund of multiple partners.
I have to admit, this does make a lot of sense to me. One of the reasons I’ve always avoided VC is the fact that I’m not keen on spending my time fighting for deals in a weekly partner meeting, or protecting my piece of the carry from fund to fund.
And the numbers can work out nicely. Imagine the hypothetical 5-year contract. Cost to the LP would be $1 million/year, plus a 15% carry. If you invested in a typical fund, you’d pay a 2% management fee and a 25% carry.
Let’s say you gave a VC fund $50 million per partner. You’d be paying management fees of $1 million/year, and a 25% carry on results. In contrast, the 5-year contract would cost you $1 million/year in compensation, and a 15% carry on results.
And if the VC did particularly well, he/she could negotiate a contract extension in a variety of ways…more money to invest, higher base comp, larger carry.
P.S. If you are a blue-chip LP and are interested in experimenting with this, drop me a line!
1 thought on “But can you fit that VC under the salary cap?”
Basically you’re talking about the VC equivalent of National Financial. This has been tried before in the hedge fund world and it doesn’t work because of adverse selection. The “good” GPs, don’t need money. Unless there is a global, macroeconomic meltdown, they are usually closed to new investors. If you’re a “good” GP, then you make more money in the current fund structure than in this sort of unitary fund structure.
So basically only the “bad” GPs are attracted to this model and that, of course, is not what an LP wants to invest in (i.e. a basket of “bad” GPs).
This is why there has never been a giant roll-up and a “brand” created in the VC space (like Fidelity in the public equity space).