Revenue Sharing with Entrepreneurs: Why and How We Do It?
We recently announced that our new fund, Glilot Capital III, will share revenues with the entrepreneurs it invests in. Since that announcement, we have been receiving many questions about the technical, as well as financial details of this move, and questions regarding our motivation to do so. Some went as far as asking if we’ve become a socialist fund. Don’t worry, that’s not the case.
In short, we, the general partners of the fund, are taking a portion of our upside and handing it over to our entrepreneurs. Our investors will not pay for it in any way, only us, the fund managers. We believe that in the long run, this will benefit the fund, its investors, the general partners and certainly the founders of the companies we invest in.
Let’s start with a high-level overview of how fund managers (aka VCs) get compensated. Fund managers are typically compensated in two ways. The first in the form of management fees, a certain percentage of the size of the fund which is paid on an ongoing basis. Management fees are intended to cover the operational costs of a fund. The second is called Carried Interest (aka Carry), which is defined as a certain percentage (typically around 20%) of the profits generated by the fund. This is designed to compensate the fund’s team (General partners, employees, and advisors) when they deliver great returns- and this is the portion of revenue that we will share with our entrepreneurs.
As some of you may know already, we have been very fortunate with our investments thus far, creating significant revenues to our investors and, accordingly, earned Carried Interest for ourselves. Carried interest is very real, it is what we work so hard for. So, why are we sharing it with our entrepreneurs?
Well, this actually feels like a natural step forward: we have always viewed our entrepreneurs as real partners and as part of our team, and, at the end of the day, they are the ones creating real value within our portfolio. If they create value for us, then creating tangible value for them is only logical. Since our earliest days at Glilot, we have been creating value for entrepreneurs, by helping their companies grow, helping them get new clients, helping them find partners and more. We also help them finalize their product offering and strategy etc. So, what is more, natural than sharing revenues as well?
On a more practical note, sharing revenues has potential benefits to Glilot. For starters, we are giving entrepreneurs even more reason to work with us. Entrepreneurs, like all business people, want to generate personal wealth. Being part of a Glilot portfolio means that the average return for a founder is likely to be high. But it’s not just about the average return, it’s more about the risk. If your returns are derived only from your own company, the risk is high. If its associated with the entire portfolio, the risk is lower. Secondly, we believe this will encourage founders to help each other. Over the years, I was pleased to learn that most founders will help other portfolio colleagues regardless of compensation — but we wanted to find a way of compensating them for their willingness to help each other. We learned In the past that portfolio companies have a very strong ability to help one another and the fund itself. They fight very similar battles and face many of the same obstacles. More specifically, a mature company can significantly help a younger company that operates in the same space -and this will give them all the more reason to do so.
Lastly, revenue sharing will improve our deal flow. To date, a big part of the companies comprising our existing portfolio was introduced to us by other portfolio companies. When entrepreneurs are happy with their investors, they are more likely to recommend us to their friends and colleagues. So Why shouldn’t we compensate founders for that, and give them better alignment with the overall portfolio quality?
So, the motivation is clear, let's discuss the details. How does it work?
Here are the highlights of the plan: The mechanism we have established is very similar to a Stock Option Plan used by many companies today. As such, the plan is based on the following components:
· Our commitment to share revenues will be inked when making the first investment in a company, as part of a separate agreement.
· The mechanism is set directly between each of the founders (personally) and Glilot. Carried interest is given to the founders, not the portfolio company. The founders cannot transfer this right to anyone else.
· The actual amount will be predetermined, meaning it will not be depended on investment details, company performance etc.
· Just like in stock option plan, each founder carried interest will vest for 5 years. If the founder is no longer employed by the company, vesting will end.
We are very excited about this new initiative, we think it has a great fit with Glilot’s DNA and a step that is in alignment with the state of the industry today.
If you have thoughts and ideas about this process and want to share it with us, please feel free to do so.