VC fees are squeezed

Much has been made of the concessions private equity general partners are making in terms and conditions in order to raise their funds. But LP empowerment isn’t limited to the private equity field: venture capitalists, who have long enjoyed slightly favourable terms in some areas, are finding that advantages like higher carried interest, the absence of clawbacks and fixed management fees are disappearing.

For the past 10 years or so, top-tier VCs have been able to charge a 25 percent carried interest. Kleiner Perkins famously charged 30 percent.  But this has changed, says venture capital fund formation lawyer  T. Hale Boggs, a partner at Manatt, Phelps & Phillips. These days, the industry standard of 20 percent reigns. 

A few firms, including Draper Fisher Jurvetson, have instituted a hurdle rate for the first time – previously a rarity in venture capital LPAs. The hurdle rates tend to be in the standard 8 to 12 percent range.

“In years past [the hurdle rate] has been more of a convention for East Coast funds,” Boggs says. “But you didn’t see them often on Sand Hill Road. Through the 1990s LPs felt pretty comfortable about the returns they were earning absent any kind of hurdle, and were not insistent upon them. But given the lower returns in recent years and the unhappiness in the LP community generally, there’s more of an expectation that they’re going to get a hurdle rate in most funds now.”

Another common private equity mechanism that many venture firms had been able to avoid for years was the clawback provision. “Virtually all” funds now include a clawback obligation, Boggs says, and many LPs are now demanding (and receiving) separate guarantees of the individual GP partners.

“For less experienced managers, some LPs push for joint and several liability against the GP members, versus several liability, meaning that any of the GP members could be liable for the entire clawback even if there are multiple GP members,” he adds.

Fixed management fees in the 2 percent to 2.5 percent range are giving way to fees that “tail off” after the initial investment period.  Some LPs are even demanding fees that are calculated based on a budget, rather than a flat percentage of capital committed – something Boggs says he’s never seen before.

“That’s tough, as I think it’s difficult for a fund manager to be able to budget precisely out a year, because it’s hard to know exactly when your opportunities are going to come up, what the market is going to do,” he says.

There has also been resistance to venture capital firms forming new funds until the current fund is substantially deployed.

“You put all those things together and there is going to be a squeeze on basic day-to-day operating and salary revenues,” Boggs says. “For smaller managers, it’s going to be pretty tight. I think one of the implications of the new VC economics is going to be smaller fund management teams because it’s a smaller pie, so having fewer mouths to feed makes it a little bit easier.”