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Venture Capital

Venture Capital · Chapter 1 of 4

How much does it cost to invest through a fund?

“Two percent is not much.” Two percent a year, for ten years, on committed capital, is a fifth of the fund before any investment.

In practice, many structures charge on committed capital in the first years and on invested capital afterwards, which eases the math. In a hypothetical example, a R$ 100 million fund with a management fee of 2% a year:

Years 1 to 5, on committed capital: R$ 10 million
Years 6 to 10, on invested capital: about R$ 6 million
Left to invest, before fund expenses: about R$ 84 million

Then comes the manager’s share of the gain, the carry. The historical reference is 20%. In a simplified example, the fund called R$ 100 million and distributed R$ 250 million. Once the capital is returned, the gain is R$ 150 million, and the manager keeps R$ 30 million. The limited partner receives R$ 220 million. The fund distributed 2.5 times what it called; the limited partner kept 2.2.

Two funds with the same portfolio can deliver very different net returns. What decides it is in the fund agreement: what the fee is charged on in each phase, whether the limited partner receives a minimum return before the manager shares in the gain, whether the manager gives back what it received in excess when the final result does not confirm it.

The structure also shows who earns from what. A high fee on committed capital rewards fundraising. A share only above a minimum return rewards results.

In the full program

Preferred return and catch-up, distribution by fund and by deal, the clawback, the money the manager itself puts into the fund and the six questions to ask of the fund agreement before signing.

Educational material. It does not recommend an allocation for any particular person; percentages and examples are references, not prescriptions.

Venture Capital · Chapter 2 of 4

Why does the fund seem to lose money in its first years?

In the third year, the report shows the fund worth 0.85 times what you invested. The natural conclusion is that the manager was poorly chosen. Most of the time, the fund is simply being a fund.

Four mechanisms pull the result down at the start. The management fee is paid from day one. New investments are marked at their entry price. The companies that fail tend to fail within two or three years. The ones that work out take five to ten to turn into cash. The shape has a name: the J-curve.

For the limited partner, the curve that matters is the cash curve. In a hypothetical example of a R$ 1 million commitment, in a ten-year fund that returns twice the capital:

Year 4, the low point: −R$ 800,000
Between years 7 and 8: what came back equals what went out
End of the fund: +R$ 1 million

You never needed to have R$ 1 million at once. You needed R$ 800,000 over four years and the patience to wait seven or eight to recover what you put in.

The curve describes time, not quality. And it is no excuse: a mature fund below 1 times is still a bad result.

In the full program

How to tell a genuinely shallow curve from one made shallow by optimistic marks, the six reading traps and the Limited Partner Cash Projection, in three scenarios, to size liquidity before signing the commitment.

Educational material. It does not recommend an allocation for any particular person; percentages and examples are references, not prescriptions.

Venture Capital · Chapter 3 of 4

How do you know whether a fund manager deserves your commitment?

Choosing a fund is choosing people: the team that will decide, for ten years, where your money goes. And the gap between managers is wide. The difference between a top-quartile fund and a bottom-quartile one, of the same vintage, is often the difference between multiplying capital and losing part of it.

Venture capital managers are, by trade, good at presenting theses and stories. The method exists to separate the quality of the presentation from the quality of the evidence.

FOUR DIMENSIONS

Team. Who decides, how long they have worked together and what happens if a partner leaves.
Track record. Money returned or estimated value, in which vintage, and achieved by people still at the firm.
Thesis. Where it invests and why this manager wins there.
Alignment. How much the partners have put in from their own pockets, relative to what they have.

“Our first fund is at 3.5 times.” The sentence calls for four questions. Is it money already returned or marked value? How did other funds of the same vintage do? Are the people who made those investments still on the team? Does the result come from several hits or from a single one?

The thesis goes through a similar test. “We invest in technology, from pre-seed to Series B, in Brazil and Latin America” describes a market, not a thesis. A thesis says why this manager sees, chooses or helps better than the others.

Two rules of use. A low score on team or alignment weighs more than a high score on track record: track record is the past, and the other two determine the future. And a score without recorded evidence does not count.

In the full program

The questions and warning signs of each dimension, how to assess a first-time fund manager, the math that shows whether the fund size fits the thesis and the Manager Scorecard.

Educational material. It does not recommend an allocation for any particular person; percentages and examples are references, not prescriptions.

Venture Capital · Chapter 4 of 4

Invest directly or through a fund?

The question usually arrives as “angel or fund?”. There is a third path between the two, the co-investment vehicle, in which the investor chooses the company and invests alongside others through a common structure. And the three are not mutually exclusive.

THREE PATHS

Direct angel. You choose the company. It costs little in fees and a lot in time.
Co-investment vehicle. You choose among the opportunities presented and come in alongside others.
Fund. The manager chooses. Dozens of companies in a single commitment, with a management fee and a share of the gains.

No path is better at everything. Each trades off time, control, cost and diversification in its own way. That is why the choice starts with four questions, not with the products. How much time can I devote each month? Where do I have a real edge, in a sector, a network or management? How many companies can I hold with direct checks alone? How much do I want to take part in decisions?

Without time for diligence and follow-up, direct investing becomes a bet. Without assessing the manager the way one assesses a company, the fund becomes a convenience.

Two cautions when combining. The ceiling on what goes into startups applies to the three paths added together, not to each one. And the same company can appear in the direct portfolio, in a vehicle and in a fund: adding up the three exposures avoids hidden concentration.

Choosing the wrong path costs more than choosing the wrong company.

In the full program

The comparison of the three paths across eight dimensions, an illustrative example of a combination within the ceiling and the Angel and Limited Partner Allocation Map, reviewed once a year.

Educational material. It does not recommend an allocation for any particular person; percentages and examples are references, not prescriptions.

Full program

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