LPs and GPs aka What is the Inner Working of a VC Firm?

VCs come in many flavors — size (small, medium, large), and focus (financial, strategic) being typically the two most prominent variables. This article will try to illuminate the key terminology about VC funds, with the goal of helping an entrepreneur understand better the industry, since even seasoned entrepreneurs are not exposed typically to what is under the hood.

LPs, or limited partners, are the investors into a fund. They could include individuals, family offices, fund of funds which are funds specialized in investing in other funds, pension funds, universities, corporates, governments especially through sovereign funds, among others. There are funds with a single LP and they are often called evergreen if the LP commitment is essentially a given. More commonly funds have multiple LPs, of differing size, almost always less than 100. This is for practical (manage relationships effectively) and legal reasons (a larger LP base is subject to different laws, topic for another day).

GPs, or general partners, are the actual investors managing the fund ie the VCs. GPs are expected to be full-time employees although you will occasionally see a GP who is also running a company. If someone is mostly an operator and consulting with the firm they may instead have the title operating partner or venture partner.

Carry is the cut that GPs accrue after disbursing profits back to LPs. The standard in the VC industry is 20% ie if VCs invested $1M and returned $11M, $1M goes back to LPs as their principal and $8M as their profit, leaving $2M for the VCs. Most funds will distribute carry asymmetrically ie the more senior GPs and the actual GP who led the deal will get a bigger cut. Carry is the equivalent of the moonshot for the VCs, the real financial and reputational upside.

Managements fees are what pays the day to day for a fund, including the GP salaries and running the office. 2% of the fund size is a typical amount. Smaller funds may have a larger number to ensure enough funds to run the firm. In larger funds GPs on the other hand a 2% might be such a large number that it can make GPs too comfortable. Which is why, beyond looking at the reputation of a firm, as an entrepreneur you should really be diligencing the specific partner and what and how he / she has invested in.

Most VC funds are structured so that you are investing the funds for 5 years and then harvesting the returns for the next 5 years. Many funds will have clauses that can extend this harvest period by a bit, say a couple years, in the case of trying to achieve higher returns. The typical situation is where a VC sees a portfolio company is likely to have an exit or an upround and it would be better to continue holding the position a little longer.

Capital calls are an art and a science of predicting how much money the VCs will deploy in the near future, 6 months to 1 year being the typical horizon. A LP may have committed $10M for the duration of the fund, which means they should expect to remit $2M every year for 5 years, assuming that’s the duration of the investment period. If GPs require more monies, say because a company is doing really well, some firms will create a specific side fund with existing or even new LPs just to invest in that opportunity.

How does all of this matter to an entrepreneur? When you are diligencing a firm, obviously the companies they have invested in, the expertise they bring, and how they would work with you are the three key factors. But a fourth important question is — how are they structured. VCs will often keep LP names and commitments under wraps but how much they share with you is also a sign of their openness and confidence levels. There are arguably also no monotonic metrics here, for instance few LPs can be great if the VC spends less time fundraising but it can also mean higher risk if a LP pulls out of the fund in the future. The key is to qualify better the fund’s track record, risk profile and overall stability.

These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). I would be stoked if they get people interested enough in a topic to explore in further depth. I work for Samsung’s innovation unit called NEXT, focused on early-stage venture investments in software and services in deep tech, and all opinions expressed here are my own.

Venture Capitalist; based in Silicon Valley since 1999

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