There are endless nuances and parameters involved in setting up and managing a venture fund. While often funds have custom provisions or side letters that cater to the needs or preferences of the GP and LPs, certain key terms tend to be similar across funds of similar sizes. Emerging fund managers, who are typically raising from entrepreneurs, high-net worth individuals, and family offices, should be aware of the standard terms that these types of LPs expect to see reflected in a fund’s controlling documents (i.e. LPA or LLCA). Understanding these standard terms will create efficiency for emerging fund managers as they establish their fund documents and structure.

Let's review industry standard terms and trends that fund managers need to know when fundraising.

Standard Fund Terms for Emerging Fund Managers

For the purpose of this article, we’ll define emerging fund managers as those who are managing their first, second, or third venture fund with a fund size under $30M. Based on our research, these funds share the following standard terms:

• Management Fees: 2% or 2.5%

• Carried Interest: 20%

• Hurdle: None

• Investment Period: 2-3 years

• Term of Fund: 10 years

• GP Commitment: ~1%

As mentioned, high net-worth individuals and family offices will largely be familiar with these standard terms, so it is often in the best interest of the fund to adhere to these standards. However, institutional investors such as pension funds, sovereign wealth funds, or foundations may have special requests for the fund’s terms, such as customized management fees or carry. In these cases, fund managers will create side letters to reflect the custom provisions.

Fund Terms Trends for Emerging Fund Managers.

While the industry standard is a helpful starting point, emerging fund managers should also pay attention to trends in fund terms. Since emerging managers tend to have a higher risk tolerance, move faster, and achieve higher returns on investments, investors and fund managers may negotiate terms that deviate from the standard if they allow the fund to execute more effectively on their specific strategy. The most common variations we’ve observed for emerging fund managers pertain to management fees, co-investment, hurdle rate, and warehousing.

Front-loading Management Fees

Typically, the management company charges a 2% annual fee to the fund to cover management services, office, salaries, and other operational expenses. However, emerging fund managers may front-load management fees by increasing the management fee during the investment period (typically the first 2-3 years) and then decreasing it in the post-investment period when the fund focuses on monitoring deals. For example, during the investment period, the management fee could be between 3%-4%. Post-investment period, the fee might be down to 0.5%.

This practice is common for first-time fund managers. Since management fees are proportional to the fund size, first-time fund managers tend to receive less than established fund managers do. Front-loading the management fees allows emerging fund managers to have the capital they need to get started and pay themselves a salary prior to receiving a return (in the form of carried interest) from their investments. Front-loading management fees allows those who do not come from generational wealth to become VCs while still making a living.

Recycled Management Fees

Management fee recycling is a tactic used by fund managers to maximize returns. Since management fees reduce the amount of capital the fund can deploy, fund managers may “recycle”, or re-invest, a portion of the returned proceeds. Recycling gives fund managers more capital to deploy, thereby increasing the amount invested and potential returns to investors. 

Hurdle Rate

In VC, the hurdle rate is the minimum rate of return before the fund manager receives carried interest. The hurdle rate can align incentives so that fund managers aim to overperform.

Typically, fund managers can expect their performance compensation in the form of 20% carried interest with no hurdle rate. 

However, first-time fund managers looking to demonstrate their ability may agree to a hurdle that gives them higher carried interest once the net multiple is above a certain return threshold. For example, if a $10M sets a 2x hurdle rate, the fund would have to return $20M to investors before the manager receives carried interest. 

Co-Investments

Emerging fund managers aim to access the best deals, which may require raising additional money to meet check minimums on occasion. In order to bolster the average check size out of their fund, some managers turn to co-investing. Co-investing allows fund managers to raise capital alongside their funds. Fund managers will set up a co-investment SPV that allows for investment from investors, whether they are investors in the fund itself or not.

Co-investing benefits all parties involved. Investors in the fund enjoy capturing more allocation in companies they love. Additional investors access deals without committing to the fund and build familiarity with the fund manager’s investment style for future opportunities. Fund managers secure deals they otherwise could not access.

Given the increasing popularity of co-investing, Sydecar’s Fund+ product supports this seamlessly. You can read more about how we structure co-investments here.

Warehousing

Before raising a fund, emerging fund managers use syndicates or angel checks to build their track records. For some investors, their existing portfolio is very attractive to potential investors. When this is the case, investors might negotiate warehousing terms.

Warehousing allows emerging investors to “store” or transfer investments that occur before the fund is set up. The investors then acquire an investment interest in these deals. Often, warehousing allows investors to participate in marked-up deals from the fund manager’s portfolio at lower valuations. Through these deals, investors can de-risk the fund. Beyond just seeing the fund manager’s track record, they take part in it.

Summary

The terms that govern your fund are no small matter. Fund terms will impact its whole strategy, including capital deployed, the target rate of return, and deal allocation. While it may be tempting, and ultimately recommended, to stick with the industry standard terms, there may be cases where custom provisions are helpful, especially if you are an emerging fund manager.