The comments on my initial post on this topic went right at the VC's compensation - management fees and carry - and their impact on returns. So at Ken Berger's suggestion, I will change my planned post for today and address the issue head on.

The returns venture firms get on their investments are called "gross returns". I didn't mention them in my post yesterday because I wanted to focus on the "net" returns to the LPs. I said 2x was the lowest attractive return on a venture fund and I meant net to the LPs. That means if you invest a dollar in the fund, you get two dollars back.

However, the fund has to get a lot more than $2 back on its investments to get its investors $2 back. That's because before the investors get their money back, the fund takes a management fee. And if there are profits, the managers of the fund take a carried interest on the profits. Our fund takes 20% and that is the carried interest that most funds take. However, there are funds that charge 25% or even 30% carried interest fees. Some think the best funds charge the highest carried interest fees. Market theory would suggest that is true. But I am not sure that it is. I think we have a very good firm and we charge a standard carry. But that's for another day, if at all. It's a tricky subject to talk about.

The management fees don't go directly to the fund managers. They pay for the costs of running the business. On small funds, that's about all they pay for. On big funds, the management fees can get large enough to pay very significant salaries to the fund managers. Management fees are all over the map but range from 1.5% per year for large funds to 2.5% per year for smaller funds. And they typically tail off after the first five years to much lower percentages to reflect that the work of putting the fund to work is largely over.

The carried interest is only paid on gains. So if they fund makes no money, no carried interest is paid. But if the gains are large, the carry will be large too.

Back in 2003, when Brad and I started Union Square Ventures, we built a model of our fund to show how we thought the fund economics could work. At that time, we planned a $100mm fund. We ultimately raised a $125mm fund.