A Million Dollars in Fees?!?!

In response to publishing our pitch deck, John Henderson shared an interesting comment about the fees we take at Notation Capital for managing the fund.

At first glance, $1M in fees does appear high as a percentage of a $6M fund (our original fundraising target). Specifically it represents 16.6% of the fund. In other words, 16.6% of the capital we raise goes to operating the fund rather than investing in startups. That kind of sucks, for our LPs (and for us). But what shocks most people is that it’s actually less than the fees taken in a more traditional 2/20 fund. We’ll break this down for you below and give you some insight into the ongoing costs of Notation Capital.

A typical fund will charge a 2% management fee and then 20% carry (ie. 20% of the profits once the fund has been paid back). That 2% fee is taken every year and since most funds run for at least 7 years (and often up to 10), a 2% yearly management fee will represent at least 14% of the fund’s capital. However, what most don’t realize is that the management fee in a typical fund does not include other ongoing expenses like legal, fund admin, among others. In fact, some LPs we spoke with didn’t quite realize they were paying these additional fees in other funds. So in a typical fund, LPs should expect to spend at least 16% of the fund’s capital in management fees and operating expenses, and likely more.

At Notation Capital, largely with Naval’s guidance and help, we’ve taken a different approach, outlined below.

Notation Capital does not have a 2% management fee, but instead runs on a budget that we share with our LPs. We’ve capped the total expenses we can spend over the entire life of the fund at $1M (including salaries, office space, fund admin, legal, etc), and hopefully we’ll spend less than that. We believe this transparency more fully aligns our spending with the interests of our LPs.

Some of our Expected Costs:

  • Alex and I each pay ourselves on average $120k per year, in line with what most seed stage CEOs might pay themselves. Note that we’ve adjusted this average for life circumstances (Alex has two kids, I don’t). So Alex pays himself a little more and I pay myself a little less.
  • Fund admin, mainly tax and accounting costs us about $35k / year. So over 7 years, we expect this to cost approx. $245k.
  • Office Space costs $2,500 / month or $30k / year.
  • Legal cost $75k to set up the fund, and we expect some ongoing costs as well.
  • We have approx. $15k budget / year for travel, events, and other unforeseen costs.

So, it’s pretty easy to see how the costs of running a fund add up quickly. At the moment, we have approximately 3 years of salary runway, and to the extent we spend more than $1M in fees, it comes out of our own pockets.

It’s also important to note that Alex and I are contributing a non-trivial portion of our own wealth to the fund. Initially, this represents approximately $150k (2% of the fund), but we’d like to do more depending on whether or not some of our ownership in previous startups becomes liquid. We’re believers in Notation Capital and our strategy. If we had the resources, we’d love to be primarily our own LPs (although in fact many of our LPs add real value).

Alex and I split the economics of the fund equally, so initially we each have 10 carry points in the fund. We’re carving out 1 point each (10% of our own economics) in order to add 10 part-time partners to Notation Capital, some of which will be announced soon :-)

In all, we believe the approach we’re taking to fees at Notation Capital is both more transparent and lower as a percentage than most funds. We’re also fully aligned with our LPs — the investors in Notation Capital know exactly how much money, down to the dollar, that goes to fees rather than investments. As most things we do and invest in at Notation Capital, this is an experiment, but one we believe is well worth trying.