A venture capitalist is not investing their own money. They manage a fund on behalf of other investors, and they have promised those investors a return. Once you see the fund from the inside, most VC behaviour makes sense: the size of company they back, the stake they want, how fast they want you to grow and when they want to sell.
Who is who
- Limited partners (LPs). The investors in the fund: pension funds, insurers, university endowments, family offices, wealthy individuals and, in the UK, government-backed bodies such as the British Business Bank. They commit money for the life of the fund and have no say in individual deals.
- General partners (GPs). The VC firm’s partners. They raise the fund, choose the investments, sit on boards and decide when to sell. They usually put in a small share of the fund themselves, often around 1–2%, so they have something at stake.
- The investment team. Analysts, associates and principals who find deals, run due diligence and write the investment papers. A partner normally has to champion your company at the investment committee before money is committed.
The life of a fund
- Fundraising (up to 18 months). The GPs raise commitments from LPs. Money is not handed over all at once; it is called down as deals happen.
- Investment period (years 1–4 or 5). New companies are added to the portfolio. A seed fund might back 25 to 40 companies; a Series A fund perhaps 15 to 25.
- Follow-on and support (years 3–8). Money held back as reserves goes into the best performers’ later rounds. Many funds keep roughly 40–60% of the fund for follow-on (a rule of thumb, and it varies widely).
- Harvest (years 6–10, often extended to 12). Companies are sold, listed or written off, and cash goes back to LPs.
This is why the timing of your exit matters to a VC. A company still growing nicely in year eleven is a problem for a fund that has to close.
How the partners are paid: 2 and 20
- Management fee. Typically around 2% of the fund each year, often reduced after the investment period. It pays salaries, offices and due diligence costs. Over ten years, fees can absorb 15–20% of the fund, so a £50m fund may only invest around £40m.
- Carried interest (carry). Usually 20% of the profit, once LPs have their money back (sometimes after a minimum return, called a hurdle). This is where partners make real money, and it only comes from big wins.
A worked example
A £50m fund pays £10m in fees over its life and invests £40m. Ten years later the portfolio has returned £150m.
- Profit over the £50m committed: £100m.
- Carry to the partners at 20%: £20m.
- Returned to LPs: £130m, which is 2.6 times their money (the net multiple).
LPs could buy a stock market index with very little effort, so they expect a venture fund to beat it by a wide margin to compensate for ten years of locked-up, risky money. A net multiple of 3x is widely seen as a strong fund (a rule of thumb). The portfolio simulator lets you run these numbers yourself.
What this means for tech founders
- A VC needs each investment to have a realistic chance of returning a large slice of the fund. See the power law.
- They want enough ownership for a win to matter, which is why entry stakes of 10–25% are common.
- They need an exit, usually within five to eight years of investing. Dividends rarely help a VC fund.
- A fund late in its life may push for a sale sooner than you would like. Ask which fund your money comes from and how old it is.
- Their incentives are not wrong, just different from yours. Knowing them lets you choose the right investor, or decide not to raise at all.
General information, not financial, legal or tax advice. Figures marked as rules of thumb vary by fund, sector and market conditions.