2.1 GP Compensation
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Carried Interest and Management Fees
General Partners (GPs) or the fund managers of a venture capital fund are predominantly compensated through a combination of management fees and carried interest. This framework is designed to ensure that fund managers maintain both the financial resources required for day-to-day operations (via management fees) and a meaningful stake in long-term fund performance (via carried interest).
The balance of these two components can vary depending on a fund’s size, strategy, and market conditions, but the underlying principle is consistent: the more profitable the fund’s investments, the greater the reward for the GPs.​​​​​
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Management Fees
Purpose and Structure: Management fees are intended to cover the operational costs of running a venture fund. These costs often include salaries, office expenses, travel for due diligence, and other administrative activities (Lerner, Leamon, and Hardymon 2012). The fee structure allows GPs to focus on sourcing, negotiating, and monitoring investments without needing to rely exclusively on future profits for their immediate cash flow needs.
Typical Range: A standard management fee in the venture capital industry is around 2 percent of committed capital per year, although this figure can fluctuate based on fund size and lifecycle stage. For example, larger funds may adopt slightly lower rates, while emerging or smaller funds might set higher fees to ensure sufficient coverage of overhead costs.
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Lifecycle Adjustments: Management fees often remain steady during the fund’s initial investment period, then taper off in later years once the bulk of the capital has been deployed. This “step-down” acknowledges the reduced level of effort required as the fund moves toward portfolio management and exit phases.
Impact on Net Investable Capital: Although the management fee is essential for daily operations, it effectively reduces the total amount of capital available for investments. Limited Partners (LPs) monitor fees closely to ensure that GPs are spending responsibly and focusing the majority of resources on generating returns, rather than incurring unnecessary expenses.​​​​​
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Carried Interest - Profit Sharing
Primary Role: Carried interest, often simply referred to as “carry,” is the share of the profits that GPs receive after the fund has returned the initial capital and any preferred returns or hurdle rates to LPs (Gompers and Lerner 2004). As such, carried interest is not a guaranteed payment; it is contingent on achieving profitable exits that surpass the agreed-upon threshold.
Standard Rates and Variations: A typical carried interest allocation is 20 percent of the fund’s profits, although this number can differ based on market competition, GP track record, and fund strategy (Lerner, Leamon, and Hardymon 2012). Some high-performing funds negotiate a “premium carry” of 25–30 percent, especially if they have a history of delivering consistently strong returns (National Venture Capital Association 2023).
Preferred Return (Hurdle Rate): Many funds include a preferred return—often 6–8 percent—before GPs are entitled to receive carried interest . This approach ensures that LPs achieve a minimum level of return on their investment prior to carry distribution, further aligning GP actions with investor interests.
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Clawback Provisions: Clawback provisions require GPs to return any overallocated profits to LPs if initial distributions exceed the final amount owed once the fund has completely wound down. Clawbacks mitigate the risk that GPs profit disproportionately from early successful exits that may be offset by weaker performance later in the fund’s life.
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Market Norms -
The "2 and 20" model
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The "2 and 20" model is the traditional compensation structure for General Partners (GPs) managing Venture Capital (VC) funds. It consists of two main components: a management fee and carried interest. The "2" refers to the annual management fee, typically calculated as 2% of the fund's total committed capital (though sometimes shifting to invested capital or net asset value later in the fund's life).
This fee is intended to cover the operational costs of the VC firm, including salaries for the investment team and support staff, office rent, travel, due diligence expenses, and administrative overhead, providing a stable revenue stream for the firm regardless of immediate fund performance.
The "20" represents carried interest, or "carry," which is the GP's share of the fund's profits, customarily 20%. Crucially, carried interest is usually paid only after the investors (Limited Partners or LPs) have received back their entire contributed capital and often achieved a minimum rate of return, known as the preferred return or hurdle rate (commonly around 8%).
This performance-based component is designed to heavily incentivize GPs to maximize fund returns, thereby aligning their financial interests with those of their LPs.
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The origins of this fee structure are often traced back to the practices of early hedge funds, particularly Alfred Winslow Jones in the mid-20th century, who combined management fees with incentive fees based on performance. This model was subsequently adopted and became the entrenched standard across the alternative investment industry, including the burgeoning fields of Private Equity and Venture Capital, especially as they grew from the 1980s onward.
For decades, "2 and 20" served as the benchmark, making it a familiar and widely accepted arrangement for LPs investing across different private funds.
While still highly prevalent today (as of April 2025), the exact terms can vary; variations might include lower or higher management fees (e.g., 1.5% or 2.5%), different carry percentages (sometimes 25-30% for highly sought-after funds), the structure of the hurdle rate, and negotiated fee discounts or step-downs, often influenced by the fund's size, strategy, the GP's track record, and the bargaining power between GPs and LPs
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For Further Reading:
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Venture Capital Fee Economics
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This AngelList Education Center page defines the two main components of VC compensation: Management Fees (typically 2-2.5% of committed capital annually, covering GP work and fund operating expenses like salaries and travel) and Carried Interest (the GP's share of fund profits, often 20%, earned after returning capital to LPs). It also touches on variations based on fund size and clawback provisions. ​
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https://www.angellist.com/learn/management-fees ​
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Carried Interest Explained: How it Works and Who it Benefits
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Odin provides a clear explanation of carried interest ("carry") as the fund manager's or syndicate lead's share of investment profits (typically 20% for funds). It illustrates how carry aligns incentives, works on a deal-by-deal basis for syndicates, and discusses related concepts like hurdle rates (minimum return needed before carry is paid) and distribution waterfalls. ​
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https://www.joinodin.com/education-centre/carried-interest ​
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Venture Capital Compensation – Goldmine or Gamble?
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The VC Factory offers a detailed look at VC economics, focusing on the standard "2/20 rule" (2% management fee and 20% carried interest). It explains how management fees fund operations and how carried interest rewards successful investments, including calculation examples and related terms like GP commit, hurdle rates, vesting, clawbacks, and distribution waterfalls. ​
https://thevcfactory.com/venture-capital-compensation/ ​
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Navigating Private Equity Fees: Carried Interest and Management Fees Explained
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While covering Private Equity, Scalex Invest clearly breaks down concepts highly relevant to VC: Carried Interest (GP's profit share, usually 20%, often after an 8% hurdle rate, aligning interests) and Management Fees (typically 2% of committed capital then NAV, covering operating costs). It also notes differences in VC (often higher management fees, less common hurdles). ​
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Understanding VC Fund Math: Key Concepts And Calculations
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Rundit includes sections defining and providing formulas for Management Fees (annual fee based on committed capital percentage, covering operational costs) and Carried Interest (GP's share of profits, typically 20%, after returning invested capital). ​
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https://rundit.com/blog/understanding-vc-fund-math/ ​
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Dividing the Pie: How Venture Fund Economics Work [Part I]
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Seraf Investor explains the two primary compensation components for GPs: Management Fees (annual fee, often ~2% of committed capital, covering salaries and fund expenses, varies by fund size) and Carried Interest (GP share of profits, typically 15-30% with 20% common, representing the main potential return for GPs). ​
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https://seraf-investor.com/compass/article/dividing-pie-how-venture-fund-economics-work-part-i ​
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