Why Entrepreneurs Should Understand Investors’ Compensation Structures And Not View The (Over) Abundance Of Capital As A Purely Good Thing
By Derek Zanutto, general partner at CapitalG
Ask any investor about their favorite podcast, and chances are they’ll immediately start gushing about The 20 Minute VC, the highly popular interview series which brings together the world’s preeminent investors and entrepreneurs for lively, thoughtful discussions about the most important but often little understood issues shaping the venture ecosystem today. It’s no wonder that the podcast has amassed more than 80 million downloads from their devoted subscriber base of 365,000 listeners.
My colleagues Laela Sturdy, Gene Frantz and David Lawee have all appeared on the program in the past. As the newest general partner to join CapitalG — I came here in 2018 from private equity where I invested in companies like Airbnb and Uber — I was thrilled to get my turn to meet with the program’s convivial and inquisitive host Harry Stebbings. I hope you’ll download the full podcast here.
Harry and I dived into a broad range of topics, covering everything from how a band playing liberal arts major (me!) ended up becoming a tech investor and following my mentor Gene Frantz to Alphabet’s independent growth fund, CapitalG, to more substantial topics like inflation rates and their impact on the investment climate, how to mitigate market timing risk with new investments, how I’m thinking about investments and valuations in the post-Covid economy, how we at CapitalG try to avoid confirmation bias when evaluating potential investments, why I see my role as a board member as comparable to a customer service agent on call 24X7 for CEOs engaged in their exceptionally demanding jobs, and why I’d like the media’s coverage of investors to focus less on the cult of individual personalities and more on the teams that come together successfully to solve important challenges on the path to building world-class businesses.
I think that for many listeners the most useful portion of the conversation will likely be our deep dive into how the oversupply of undisciplined capital across every stage is creating confusion for entrepreneurs who are trying to make sense of their options. My recommendation to entrepreneurs is to explore what the investors are hoping to achieve from the partnership in part by digging into how each of them makes money. Typically, investor compensation structures will involve a combination of 2 percent management fees charged annually and a 20 percent share of the profits on successful investments. Since investors typically fundraise every 3–5 years, those management fees begin to stack on top of each other. As a result, younger funds’ partners will make nearly all of their money based on how well their underlying portfolio companies perform, while older funds will be less sensitive to underlying investment performance, given the steady stream of stacked management fees. The financial weighting from any one investment can signal how much time an investor may be willing to devote to that company. I also recommend that entrepreneurs look into potential investors’ existing board commitments. A substantial number of simultaneous board commitments can make it tough for investors to devote sufficient time to each of those businesses.
Finally, no conversation about investing could possibly be complete if I didn’t mention what a privilege it is to work every day with my talented colleagues at CapitalG, as well as the incredible entrepreneurs with whom I’ve privileged to partner, such as Yevgeny Dibrov and Nadir Izrael at Armis, Felix Van de Maele at Collibra and Florian Douetteau at Dataiku to name a few.
I had so much fun digging into these consequential topics and hope that you’ll take the time to listen to the full podcast here.