To understand how a leveraged venture capital fund works, you first need to understand some basics of how a traditional VC fund operates.
VC funds collect capital from Limited Partners who invest in the fund. The fund then invests this capital, assists the companies in growing and working towards a liquidity event and then returns capital and profits to investors. The fund typically charges a 2% management fee and 20% carried interest to compensate them for all the work. This means that after an investor receives 100% of their investment back, they also get to keep 80% of the profits.
A leveraged fund works just like a regular fund, except that it works double hard to benefit Limited Partners by creating “syndicates” or groups of investors on a platform like AngelList which then charges a carried interest to those platform investors. The AngelList carried interest is also 20% and the platform keeps 5% and the syndicate lead, who in this case is the venture capital fund, gets to keep the 15% carried interest which it then distributes to its Limited Partners.
So how does this work?
Imagine that the VC is going to invest in a company that is looking to raise $1 million. The VC may invest $500,000 of its own money in the company and then act as syndicate lead on AngelList for the remaining $500,000. If the company was selling 20% of its equity, then the VC would own 10% and the AngelList syndicate would own another 10%. Now imagine that the company has a 3X exit, so the VC gets $1.5 million and $1.3 million is distributed to Limited Partners. (LPs get their original $500,000 plus 80% of the $1 million profit) The AngelList investors get $1.3 million too. But now, the VC also received another $150,000 in carried interest from the AngelList syndicate which is also distributed to its LPs (less the 20% carried interest), so they receive an additional $120,000. The LPs thus had only an 8% net carried interest on the deal thanks to the leverage strategy and they put an additional $120,000 in their pockets which they would not have seen from a traditional VC fund.
For a leverage fund to work it has to have all the elements of a great Venture Capital fund in the first place. They have to have a lot of deal flow and have the ability to pick the best opportunities and coach them along the way to a successful liquidity event. They need to have a solid portfolio of companies that would provide excellent profits to LPs without the leverage. But if all these things are in place, and then a leverage component can be added, then Limited Partners can see a significant benefit.
To learn more about Rockies Venture Fund and leveraged VC fund investing, visit us at www.rockiesventurefund.com
Peter Adams is Executive Director of the Rockies Venture Club, Managing Director of the Rockies Venture Fund and teaches in the Colorado State University MBA Program. Peter is co-author of Venture Capital for Dummies, (John Wiley & Sons 2013) Available at Amazon, Barnes and Noble and your local book store.