How Do Venture Capitalists Really Make Money?

If you really want to understand a business figure out how it makes money. That's true for every kind of business. It's especially true in venture capital. Most people think about venture capital in terms of single deals. A VC's job is to essentially buy low and sell high. That takes a ton of work.

In future episodes we'll take a look at how an individual VC deal makes money. Ultimately, however, venture capitalists make their money by managing a fund of venture investments for other people. So that begs the question: How do venture capital funds make money? VCs get paid with a management fee (1-3%) that should cover the costs of keeping the lights on. It's a nice living, but not the reason someone becomes a venture capitalist. Venture capital funds get "carry" which is a share of the upside, usually 20% of profits. Carry is the brass ring. The lion's share of the money. The economic motive for VCs is to make a huge amount of money for other people and share in that success.

In this episode we look at three articles by venture capitalists that explain how the math works for a VC fund to be successful. The math is somewhat non-obvious. Take a listen and find out how it works.

Cem Sertoglu, Early Bird Venture Capital - VC Fund Economics

Cem Sertoglu provides a brief Cliff Notes style guide to venture capital fund economics. (HUGE apology to Cem for butchering the pronunciation of his name. My Turkish is non-existent and I couldn't find any pronunciations on the web. Sorry!)

Mark Suster, Upfront Ventures - How to Build a Startup & Understanding Venture Capital

Mark Suster goes more in-depth than Sertoglu. As part of his pitch at venture conference, Suster explained three things: the right mindset for founders, understanding how venture capital works and how to build a great team. His slides on how venture funds make money summarize beautifully. He's also very clear about why this matters to founders raising capital.

Benedict Evans, A16Z - In Praise of Failure

Evans lays out a PhD level class for understanding how venture capital funds really make money, and don't. The data he presents from Horsely Bridge blew me away. Not because of any surprise outcome, but because of the vast data set. There's not a lot of arguing about the conclusion: "Go way way beyond big or go home." I could not love this post more, unless we got to see the names of the 50%, (yes half!) of the funds in the data that failed to return 1X their investors capital.

Bonus Content - More About Mark Suster

How he describes himself: 2x entrepreneur. Sold both companies (last to @salesforce). Now @UpfrontVC looking to invest in passionate entrepreneurs.

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