How Angel Investors, Venture Capital firms, and Angel Groups make money?

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For angel funds, venture capital funds and other investment partnerships, there are often complex formulas for how the individuals involved in managing investments make money.

Angel Investors
Angel investors typically make investment decisions regarding startups without paying others to manage their money. Therefore, the return on their investment usually won’t involve paying any intermediaries. This can make a startup investment more attractive than alternative high-risk investments that usually involve paying a broker, money manager or another financial intermediary.

Angel Funds
There’s a growing trend for angel investors to come together and invest as a fund. Typically, these funds make investments ranging from $100,000 to $500,000 at one time and occasionally are supplemented with private investments from individual angels. These funds tend to be small in size, which makes it difficult to afford full-time investment professionals to manage the fund. Nevertheless, a significant amount of time is spent on meeting organization, decision coordination and due diligence required to manage these bands of angels and fulfill the promise of the angel fund model.

Therefore, more often than not, angel funds have one or more investment professionals–often working part-time–paid as managers for the fund. Their compensation involves cash and a bonus tied to the fund’s performance. The exact nature of this compensation is related to the fund’s origins. If the fund was initiated by its managers, the compensation is usually more substantial and tied closely to the performance of the investments the fund makes. If the fund was initiated by angels who subsequently hired a manager to handle the meeting coordination, the compensation formula is skewed toward cash rather than performance bonus.

Venture Capital Firms
Warren Buffet famously describes some investors as the “2 and 20 crowd.” This refers to the formula that has become popular among many investment funds–particularly hedge funds that invest in the stock market, but also venture capital funds that invest in private companies–when compensating fund managers.

The investment management fees are calculated as 2 percent per year of the total size of the fund plus 20 percent of the upside return. Some venture capital firms with specialized skills or outstanding reputations can justify fees of 3 percent and 25 percent to 30 percent of the upside, but most tend to charge fees in the “2 and 20” range. The fees are paid by their investors, often called limited partners. This means that a $500 million fund generates $10 million in fees per year, even before it’s earned any of the upside returns. That’s enough to pay generous salaries to several partners, associates and support staff.

Since the real legwork for most venture capital firms is done by associates and other non-partner investment professionals, such as vice presidents and principals, it’s actually more helpful to study their compensation.

The typical associate earns an annual salary of $100,000 to $200,000. That amount is usually higher for associates based in competitive markets, such as New York City, or those working for larger funds. In addition, some funds allow associates, VPs and principals to earn some of the upside of the investments the fund makes, often called a carried interest or “carry.”

Most VC funds encourage associates to find attractive deals that get funded to increase their salary or their carry. It’s not unusual for associates and non-partner professionals to toil for many months or years before successfully finding a deal that gets funded, let alone one that gets funded and achieves liquidity for the investors. Evaluating performance of non-partner professionals is very difficult if the returns are only realized many years later, often after the associate has moved on to another job. This leads to a culture that many entrepreneurs complain about: The associates have the power to say “no,” but not “yes.

 

kreta Train Answered on September 7, 2015.
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