Let’s be honest – when we talk about VC performance, the conversation almost always boils down to one thing: “Can this GP pick winners?”
It’s the sexy part of the business. Finding the next unicorn. Backing visionary founders. Nailing the perfect thesis.
But here’s what most people miss. Behind the scenes, savvy GPs use specific un-sexy tactics to juice returns.
Here are four (non-mutually exclusive) levers a GP can pull to maximize returns … once they consult all of their tax and financial advisors to make sure it works for their specific situation, of course 😉
1. Please, keep my money (Recycling)
When a VC exits an investment, instead of sending that cash back to LPs, they can “recycle” it by investing it right back into new companies.
Fred Wilson of USV breaks it down in this post: “A $100mm fund will pay about $20mm in management fees over ten years. So it would only actually invest $80mm into startups. But by recycling $20mm back into new investments, you’ve suddenly put the entire $100mm to work.”
I’ve seen this myself in a couple of funds I’ve invested in. They both had some early (modest) exits, and they’re recycling the proceeds so more money is getting put to work on behalf of me and the other LPs.
2. Call ahead (Collect “out year” management fees earlier)
When a new firm launches, those management fees are survival money. But as firms mature with multiple funds under management, it’s less hand-to-mouth. Those “out year” fees (years 4-10) aren’t as critical to keeping the lights on once a firm has scaled.
So what if, instead of calling those fees in year 5 or 6, you accelerate them into years 1-3 when you’re actively deploying capital? I’m an investor in a fund who did just that, and I was happy to see it. After all, it’s another way to put more capital work on my behalf.
3. Free money (Warehousing your angel deals)
You need to set this up properly (another thing to take to your lawyers and financial folks), but if you check all the right boxes, there is a way you can take your angel investments and roll them into your fund. LPs generally love this because they’re getting these deals “for free” (including any markups those investments have received) even though the fund may not have deployed a dollar of capital yet.
4. Let them keep writing checks (Pro-rata delegation)
When investing, most VCs will look to get pro-rata rights so that they can keep their ownership percentage level as their portfolio company raises more rounds of capital. Small funds often don’t have the capital reserves needed to leverage these rights consistently, so they get diluted.
However, there’s a solution! For the best companies in the portfolio, it’s likely there’s an LP or two who would be happy to give the GP some economics in exchange for the chance to put more money to work via that pro-rata right.
Again, a GP can mix and match these strategies based on the situation at hand. Use one or use them all – after doing your diligence and asking all the right questions, of course!
