VCs often use the shorthand phrase “two and twenty” to refer to the 2% of annual management fees a venture fund might take and the 20% carried interest (or “performance fee”) it would charge. In a nutshell: If a venture fund turns a $100 million profit from its investments, the fund gets to keep $20 million of that, and the remaining $80 million is paid out to the limited partners.
The “2 and 20” fee structure was originally associated with hedge funds, but VC firms and other investment funds use it as well. The structure breaks down into two types of fees: a management fee and a performance fee.
The management fee is a yearly charge calculated based on the total assets under management (AUM). Typically, the management fee is 2% of AUM, but new data from Carta shows that the 2% figure isn’t as universal as you might have been led to believe.
First, it’s useful to understand what the management fee is for. Basically, it compensates the fund managers, regardless of the fund’s performance. So a VC firm that charges a 2% fee for managing a $100 million fund will receive $2 million per year to cover rent, staff costs, marketing, travel and, well, everything else.
The other part of the compensation is the carried interest — the portion of the profits that the VC firm takes once investments start paying off. Most commonly, this is set at 20% of the fund’s profits, with the idea being it works as an incentive to encourage the VC firm to maximize returns. Yes, just getting paid the management fee can be lucrative, but the get-rich-slow scheme for venture capitalists is the carry, as their compensation increases when the fund performs better. There are also variations to these fee structures — for instance, performance fees might only apply once a certain hurdle rate or minimum return is achieved.
So while 2 and 20 is a pretty common shorthand, I was intrigued to learn from Carta’s head of insights, Peter Walker, that the numbers are actually not as set-in-steel as we think.
Two percent appears to be the most common fee rate, especially for funds with less than $100 million in AUM. Above that, though, the rate climbs to a median of around 2.5%. More than 50% of small funds that manage $10 million or less enjoy a 2% management fee, but nearly three-fourths of the funds that manage $500 million or more are able to claim 2.5% management fees, per Carta data.
Fund management fees. Image Credits: Carta
Obviously, larger funds also have more administration to do, but given that they start from a higher base to begin with, it means they collect at least $12 million per year.
It’s worth noting that the data is for the initial period of each fund, which is usually the first two years of a fund’s investment period. Some funds are structured so that the management fees drop gradually after the initial investment period.
FAQs
Two refers to the standard management fee of 2% of assets annually, while 20 means the incentive fee of 20% of profits above a certain threshold known as the hurdle rate.
What is the 2 and 20 hurdle rate? ›
A two-and-20 arrangement is a common fee structure for hedge funds, private equity, and venture capital firms. The fund charges investors 2% of assets under management plus 20% of profits over a hurdle rate annually. Typically, the hurdle rate is 7% to 10%.
What is 20 carry in venture capital? ›
The 20% of the two and twenty
This is better known as “carry” in the industry. Once the general partners distribute capital back to all the investors, they get 100% of their money back. Every dollar after that there is a profit-sharing component. The VC general partners can charge the limited partners a standard 20%.
How many VC firms fail? ›
And yet, despite all that cash flowing into VC-backed companies, twenty-five to thirty percent of them will fail. One in five fail by the end of their first year; only thirty percent will survive more than ten years.
What is 2 and 20 private equity structure? ›
This is also known as the “2 and 20” fee structure and it's a common fee arrangement in private equity funds. It means that the GP's management fee is 2% of the investment and the incentive fee is 20% of the profits. Both components of the GPs fees are clearly detailed in the partnership's investment agreement.
What are the 4 C's of venture capital? ›
How VCs can ensure responsible behavior without excessive regulation through The Four C's “Conviction, Compliance, Confidence, and Consequences.”
What is a hedge fund 2 and 20 example? ›
You choose to place that money in a fund charging two and twenty. Over the course of one year, you'll pay roughly $2 million x 2% = $40,000 for the 2% management fee. If during that year, the fund returned 20%, your $2 million would grow by $400,000 to $2.4 million.
What is the most common hurdle rate? ›
Hurdle rates in private equity typically range from 7% to 8% but can vary based on the fund's strategy and the agreement between LPs and GPs. Only after reaching the hurdle rate do GPs start receiving their share of the profits, often about 20% of the fund's returns above the hurdle rate.
Is WACC the same as hurdle rate? ›
Most companies use their weighted average cost of capital (WACC) as a hurdle rate for investments.
Do VC funds have hurdle rates? ›
Carry is typically paid out after the limited partners (LPs) — the people who put money into VC funds — have received a return on their investment. This is usually 1x their original investment increased by a hurdle rate, which is the minimum rate of return required on a project or investment, which can vary.
My simple advice when you raise capital: assume you have to return a liquidity event (sale or IPO) of at least 10x the amount you raise for raising venture capital to be worth it. Valuations change from round to round. Later stage investors will expect lower ROI, seed investors will be looking for a lot more.
What is the 100 10 1 rule for venture capital? ›
100/10/1 Rule - Investor screens 100 projects, finance 10 of them, and be lucky & able to enough to find the 1 successful one. Sudden Death Risk - Where the founder stops/loses capability to work on the idea. Investors usually choose the incubator strategy to avoid this risk.
What is the most successful VC firm? ›
Following is a list of the top 15 venture capital firms in 2023.
- Sequoia Capital. AUM: $28B. Location: Menlo Park, CA. ...
- Andreessen Horowitz. AUM: $35B. ...
- Kleiner Perkins. AUM: $6.8B. ...
- Khosla Ventures. AUM: $15B. ...
- New Enterprise Associates (NEA) AUM: $20B. ...
- Founders Fund. AUM: $11B. ...
- First Round Capital. AUM: $3B. ...
- Accel. AUM: $50B+
The decline in fundraising is also happening at a time when VC dry powder of $302.8 billion is at a record high. Most of this dry powder belongs to funds that were formed in 2021 and 2022.
How rich are VC partners? ›
Thus for a typical portfolio—say, $20 million managed per partner and 30% total appreciation on the fund—the average annual compensation per partner will be about $2.4 million per year, nearly all of which comes from fund appreciation. And that compensation is multiplied for partners who manage several funds.
What is the 2 percent rule in investing? ›
One popular method is the 2% Rule, which means you never put more than 2% of your account equity at risk (Table 1). For example, if you are trading a $50,000 account, and you choose a risk management stop loss of 2%, you could risk up to $1,000 on any given trade.
What is rule of 20 in accounting? ›
The rule combines two key factors: the Price-to-Earnings (P/E) ratio and the expected earnings growth rate of a stock. In essence, the fair value P/E ratio should equal the expected earnings growth rate plus 20.
