Fee Airbag: Get Paid Win or Lose
Books Teaching This Pattern
Evidence
The Finance Princes - The Story of the Swedish Venture Capitalists
Lotta Engzell-Larsson · 4 highlights
“But exactly what do today’s sailors, the partners in venture capital firms, risk? Primarily, they risk their reputation and career; if a fund performs poorly, it will be hard to raise money for the next one. But during that time, they can make quite a bit of money. The setup is that if the fund manages to give investors a return on capital above a certain agreed threshold, eight percent per year, the annual management fee is repaid and the partners get their share of the profit. If, on the other hand, the partners fail, they keep the fee, which is 1.5–2 percent of the total capital. (The size varies between different venture capital firms, and the level is a little higher at the beginning and lower towards the end of the fund’s “life.”) In a fund of 10 billion, the venture capitalists can thus take out an average of around 200 million per year. The fee is meant to cover the cost of salaries for the ten to twenty people working with the fund and expenses that arise in finding investments. But it is mainly costs for deals that do not materialize that they are forced to cover. When a purchase does go through, the costs are transferred to the acquired company.”
“The problems there arose when Altor tried to build a total service model based on a foreign example. Major customers like Telia, who had spun off Relacom a few years prior, resisted. Harald Mix expresses it as “we underestimated our negotiating position vis-à-vis the large customers.” What had the partners lost? Probably not that much. It’s true that they themselves invest 1-2 percent in the funds in which they operate, but even if the fund performs poorly, they still get to keep the annual fee. And if the fund performs well, there will be a profit not only on the capital the partners have invested, but also on the profit-sharing “carried interest” they receive as a reward from the other investors in the fund. Because the annual fee serves as a cushion, the risk is not that high for the partners. They, unlike the investors, get paid no matter what.”