Start Here: What Even is A VC Fund?

Why understanding the structure of a VC fund is crucial for your startup journey.

When I first started out, I always imagined a VC fund looked a little something like this:

Turns out the more I dig in, it starts to feel like VC funds more closely resemble this:

Between managing their startups, the investors in the fund, navigating the economic and legal environment, it’s no wonder why the world of VC seems so hectic especially to newcomers to the field.

In order to explain the VC world, it’s crucial we start from the beginning and break down the structure of the Venture Fund and define all of its components.

I promise by the end of this, we’ll all have a bit clearer picture of what a VC is, and the implications the structure has on how you should approach VCs.

So here’s the basic structure of a venture fund:

There’s a lot here, so let’s break it down starting from what’s most familiar.

Portfolio Companies

That’s you!

These are companies that the fund has invested in. Typically the fund will choose to invest in companies that all share a specific characteristic - be it stage, industry, B2B or B2C, or something else altogether.

General Partners (GPs)

These are who you think of when you thing of VCs. They provide the investment expertise to the fund and will conduct due diligence in deciding what startups to invest in.

GPs have effectively all of the control when it comes to investment management, but in doing so, they also assume effectively all the legal liability if things go south.

The General Partners will typically invest a small amount of their own capital into the fund as a way to signify that they have “skin in the game” and will make better decisions with the LPs capital.

In return for their investment expertise, the GPs are paid a fraction of the fund’s returns, typically around 20%. This payment is called “carried interest” or “carry” for short.

Limited Partners (LPs)

As shown in the gif, this is typically where most of the money comes from. These limited partners provide the fund money with the expectations that the general partners will generate an outsized return for them.

As their name implies, limited partners only have limited liability when it comes to legal issues that arise from the investments made.

Limited partners can come from a variety of places, but there are three main sources:

1. Institutions (Pensions, University Endowments, Foundations, etc.)

2. Corporations

3. High Net Worth Individuals (Jay Z, Bill Gates, Kim Kardashian, etc.)

Management Company

This is the actual operating business of the venture fund. They take care of the day-to-day items such as running the office, marketing of the fund, paying salaries, and more.

Who pays for this all?

The fund of course! Normally we see that each fund under management has a specified management fee allocated. On average that ranges from 1-3% of the fund value, per year.

The Fund

This is the most important piece. The fund is a legally binding agreement, typically in the form of a 100+ page document (called a Limited Partnership Agreement), that lays out the relationship between the general partners, limited partners, management company, and future portfolio companies.

The sole purpose of the fund is to make investments in companies. Nothing else.

The fund may have a finite amount of time to be in operation - typically 10 years. GPs budget out money for 3 years of new investments for a fund, and after that they will typically fundraise a new fund (usually called Fund 2) or just focus on management of Fund 1’s investments.

What does this mean for me?

First congratulations for making it through that bit of legal definition and jargon.

1. General Partners Have Limited Partners to Answer to.

Although they do have most of the control when it comes to deciding which companies to invest in, they still have pressure from external parties to make good investments. If they do not produce a sufficient return, they will have an incredibly hard time raising another fund.

2. General Partners Real Income Comes From Carried Interest.

General partners do end up having a secured salary through the management fee, however the true upside available for them is through the return that your company provides the VC firm through their investment.

Your acquisition or IPO is what really pays the bills.

3. You Should Feel Empowered to Ask About the Fund’s Structure

Just like a VC is asking you about how your business is structured, you should feel empowered to do the same.

Knowing where their money is coming from is critical for understanding how a specific firm will choose to invest. This can heavily influence the methodologies and styles that the general partner employs in how they interact with you over the lifetime of your company.

In Conclusion…

Congratulations on making it to the end of this article! You’ve learned about the structure of a VC fund, and what those implications mean for you as a growing entrepreneur.

This is the foundation that we will build off of to develop our understanding of VC as a whole. In the coming articles, we’ll talk about the economic implications much more deeply between the management fee, carried interest, profits, and more.

*Throughout this article I employ the word “typically” and “normally” - please note that there is a wide diversity of VC fund structures and management practices. This article serves as a starting point for us to explore and appreciate the unique differences amongst various firms.

*Much of this article was learned and adapted from learnings from Module 1 of VC University online presented through UC Berkeley and NVCA.

*Thank you to Daniel Miller of Rolling Thoughts for providing feedback on an initial draft of this article.

❓A Short Question For You…

If I could write the next article a question you have around VC Funds, what would that be and why?

Please do share your thoughts below in the comments!