[sector]

VCs are (primarily) investing other people's money. The basic overview is this:

VC raises a $100m fund that is expected to last for 10 years. They charge a 2%/yr management fee, for their work as investors. Then, they also keep 20% of the gains from their investments.

So if the fund operates for 10 years and exits for $400m, my understanding is that they'd take $20m for managing the fund, plus $60m "carried interest", and return the rest to the limited parters (the investors whose money was actually at risk).

If the fund operates for 10 years and the companies sell for a combined total of $50m, they still charge the $20m management fee, and the investors have $30m returned to them.

Thus, VCs themselves have very limited downside.

[anothermachine]

That seems insane. Why would a wealthy (and presumably intelligent) investor hand over 20% of gains to someone with no skin in the game?

I guess if the VC had a track record from which to estimate expected returns, it could be a big deal, but no one has a track record, because these business cycles are so short.

If were a multi-millionaire, why wouldn't I say "Hey Mr. VC, if you think you can turn $100M into $400M, why don't you borrow it from me and pay 10% interest?"

[sethg]

You can usually get a 10% annual return by investing in regular stocks. The kind of investors who put their money in VC firms are looking for higher returns.

Let’s say I invest a million bucks in my local VC fund, and its investments earn back an annualized 15%/year over ten years. My million bucks has turned in to a little over four million. After paying the fees, I would still be about a million dollars ahead of someone who got a 10% return from a regular mutual fund.

[damoncali]

It's not really 20%. It's 20% of whatever is left after the limited partner clears their hurdle rate. And to a degree, it is a bit insane, especially when you look at the historical returns of venture capital. But you'll find similar structures throughout the finance world - hedge funds, real estate, leveraged buyouts, etc.

To me, the crazier part is the 2%.