VCs often use the shorthand phrase “two and twenty” to refer to the 2% of annual management fees a venture fund might take and the 20% carried interest (or “performance fee”) it would charge. In a nutshell: If a venture fund turns a $100 million profit from its investments, the fund gets to keep $20 million of that, and the remaining $80 million is paid out to the limited partners.
The “2 and 20” fee structure was originally associated with hedge funds, but VC firms and other investment funds use it as well. The structure breaks down into two types of fees: a management fee and a performance fee.
The management fee is a yearly charge calculated based on the total assets under management (AUM). Typically, the management fee is 2% of AUM, but new data from Carta shows that the 2% figure isn’t as universal as you might have been led to believe.
First, it’s useful to understand what the management fee is for. Basically, it compensates the fund managers, regardless of the fund’s performance. So a VC firm that charges a 2% fee for managing a $100 million fund will receive $2 million per year to cover rent, staff costs, marketing, travel and, well, everything else.
The other part of the compensation is the carried interest — the portion of the profits that the VC firm takes once investments start paying off. Most commonly, this is set at 20% of the fund’s profits, with the idea being it works as an incentive to encourage the VC firm to maximize returns. Yes, just getting paid the management fee can be lucrative, but the get-rich-slow scheme for venture capitalists is the carry, as their compensation increases when the fund performs better. There are also variations to these fee structures — for instance, performance fees might only apply once a certain hurdle rate or minimum return is achieved.
So while 2 and 20 is a pretty common shorthand, I was intrigued to learn from Carta’s head of insights, Peter Walker, that the numbers are actually not as set-in-steel as we think.
Two percent appears to be the most common fee rate, especially for funds with less than $100 million in AUM. Above that, though, the rate climbs to a median of around 2.5%. More than 50% of small funds that manage $10 million or less enjoy a 2% management fee, but nearly three-fourths of the funds that manage $500 million or more are able to claim 2.5% management fees, per Carta data.
Fund management fees. Image Credits: Carta
Obviously, larger funds also have more administration to do, but given that they start from a higher base to begin with, it means they collect at least $12 million per year.
It’s worth noting that the data is for the initial period of each fund, which is usually the first two years of a fund’s investment period. Some funds are structured so that the management fees drop gradually after the initial investment period.
FAQs
VCs often use the shorthand phrase “two and twenty” to refer to the 2% of annual management fees a venture fund might take and the 20% carried interest (or “performance fee”) it would charge.
What is the 2 20 model of venture capital? ›
Two refers to the standard management fee of 2% of assets annually, while 20 means the incentive fee of 20% of profits above a certain threshold known as the hurdle rate.
What is the 2 and 20 rule in private equity? ›
The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.
What is the 2 and 20 hurdle rate? ›
A two-and-20 arrangement is a common fee structure for hedge funds, private equity, and venture capital firms. The fund charges investors 2% of assets under management plus 20% of profits over a hurdle rate annually. Typically, the hurdle rate is 7% to 10%.
What is the typical fee structure for a VC fund? ›
Most VC funds operate on a cleaner model which is generally 2% Management Fees and 20% Carry. The management fees structure changes to 1% in post deployment period. However, I have also seen many funds in their 3rd/4th cycle where they have reduced their management fees to 1.5% and increased their carry.
What are VC standard fees? ›
2 VC fund fees
Management fees are annual payments that cover the fund's operating expenses, such as salaries, rent, travel, legal, and administrative costs. Management fees are usually calculated as a percentage of the fund's committed capital or invested capital, and typically range from 1.5% to 2.5% per year.
What are the 4 C's of venture capital? ›
Let's not invite that risk, and instead undertake conviction, compliance, confidence and consequences as an industry. It can not only help us preserve the best parts of the current industry, but also lead to better investments and a healthier innovation sector.
What is 2 2 1 venture capital? ›
On the other hand, 2-2-1 — two seats for the founders, two for the investors and 1 outside member — could lead to the founders losing control of their own company. These are not a main focal point. They are simply a modest deal sweetener and usually range between 5% and 15%.
What are the three types of venture capital funds? ›
Types of Venture Capital Funds
Venture Capital Funds are classified on the basis of their utilisation at different stages of a business. The 3 main types are early stage financing, expansion financing, and acquisition/buyout financing. There are 3 sub-categories in early stage financing.
What is the minimum net worth for private equity? ›
The minimum investment in private equity funds is typically $25 million, although it sometimes can be as low as $250,000. Investors should plan to hold their private equity investment for at least 10 years.
Do you know the Rule of 72? It's an easy way to calculate just how long it's going to take for your money to double. Just take the number 72 and divide it by the interest rate you hope to earn. That number gives you the approximate number of years it will take for your investment to double.
What is the rule of 72 in private equity? ›
The Rule of 72 is a convenient method to estimate the approximate time for invested capital to double in value. By merely taking the number 72 and dividing it by the rate of return (or interest rate) expected to be earned, the output is the approximate number of years for an investment to double.
What is the hurdle rate of a VC fund? ›
A hurdle rate is a specified minimum return below which the general partner cannot share in the profits of the fund. The IRR is the actual rate of return earned by the fund, which may be above or below the hurdle rate.
What is the VC hurdle rate? ›
The VC hurdle rate (i.e. the VC's required rate of return) is then calculated by dividing the required return on equity calculated using CAPM, for example, by the probability of success. So, if the CAPM return on equity is 15% and the probability of success is 30%, the VC hurdle rate is 50%.
Is WACC the hurdle rate? ›
Most companies use their weighted average cost of capital (WACC) as a hurdle rate for investments.
What discount rate do VCs use? ›
Purpose - – Venture capitalists typically use discount rates in the range of 30-70 percent. During the startup stage of venture-capital financing, discount rates between 50 and 70 percent are common. The discount rate decreases from the first through fourth stage: from 60 to 30 percent.
Does II charge exit fees? ›
The phasing out of exit penalties is good news for investors. Whoever you choose to invest your money with, if you're not happy with any aspect of your portfolio, you should have the freedom to move some or all your money elsewhere without losing a chunk of it. interactive investor removed exit fees five years ago.
What are discount rates for VC? ›
The discount rate will be the VC firm's desired rate of return of 30%. The discount rate is usually just the cost of equity since there will be zero (or very minimal) debt in the capital structure of the start-up company.
Do VCs charge management fees? ›
technical Venture funds typically charge 2–2.5%* in management fees. You'll often hear VCs refer to management fees as a charge for the cost of handling all “assets under management.” Given this, if a $100M fund charges even a 2% fee in the first year of their fund, then the management fee would be $2M.
