Book Review: Whistleblower

Susan Fowler's memoir and some thoughts on whether VCs can play a role in improving the culture in technology companies

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Many of you may recognize Susan Fowler as the woman who wrote the blog post about her experience as an engineer at Uber that kicked off a firestorm in Silicon Valley by exposing multiple instances of sexism, sexual harassment, and a culture that would not support addressing those problems.

If you are wondering what she is up to nowadays, she is an Opinions editor at the New York Times and has written a memoir called "Whistleblower" that came out yesterday. I’m glad that she has the opportunity to share her story and advocate for change.

Fowler’s life story by itself is compelling and this book details her upbringing, education, early career, and finally her time at Uber. What comes across clearly is how Fowler pushed to fight roadblocks at each step of her journey from of a homeschooled kid from a poor family in Arizona to an undergraduate student at ASU & University of Pennsylvania (which was a particularly painful part of the story), to a career as an engineer, and ultimately as a writer.

This book was painful to read at times, but ultimately empowering. You might think the book is about harassment at Uber but it is more than that. It is the story of someone who has been fighting for space within systems (both academic and professional) that would rather see her silenced and stifled for the majority of her life and how she was able to ultimately fulfill her dreams.


Thoughts after reading:

Can VCs help?

I’m genuinely not sure. Before reading this book I thought about VC firms that I would trust with this role of being the forcing function for better cultures within tech companies, and Kapor Capital was one of them (run by Mitch Kapor and Frieda Kapor Klein) but I realized that they were investors in Uber. They published an open letter after Fowler’s post saying that they were attempting to make a change from the inside, but weren’t able to make progress. In the book Fowler talks about how knowing that investors knew that the culture was broken but did not/could not do anything meaningful just made the whole experience even worse.

  • Could VCs (given their financial interest to support portfolio companies) effectively be another back stop for whistleblowers? I’m skeptical.

  • The power of venture firms within late stage companies is weak, especially in the age of founder friendliness and abundance of capital. Even to stage an intervention at the board level requires overcoming a lot of inertia. Agreeing not to fund founders who fail reference checks will not prevent a less scrupulous fund from investing

  • Many VC firms themselves aren’t exactly known for their approach for D&I within their own firm, though things are improving. How much we can trust a firm to extend help on this front to portfolio companies is unclear.

  • What could VCs actually do: Encourage industry wide reporting of employee turnover and form an independent ombudsman organization with the power to receive (and investigate) complaints of harassment or discrimination within portfolio companies.

  • It’s tricky to introduce simple metrics like # of HR complaints when you consider the incentives that new metrics will create (simply reporting # of HR complaints will create an incentive to discourage employees from lodging a complaint)

  • Example of something positive: Brianne Kimmel meets with “every new female hire of her portfolio companies to ensure her companies are thoughtful about D&I from the beginning”

Tech Perks?

Tech companies offer a lot of perks from the food, to “unlimited vacation”, to the massages at work, but the only thing that seems hard to find is a supportive environment that allows people to do their best work, grow professionally, and management that does not tolerate those who would create a hostile environment. All of the other perks should be the cherry on top. It doesn’t matter how many micro-kitchens you have and what kinds of fancy standing desks your employees are being forced out of the teams that best match their skills because their manager propositioned them or incurring significant damage to their mental health.

The other more visible perks (“nap pods anyone?”) are easy to spot but the ability to detect a culture that is genuinely supportive is hard to find. When people ask me for help choosing between companies, I often suggest contracting with companies first to get a better picture of the working environment (if their financial & health care situation supports that possibility).

Whisper networks

Whisper networks work great for someone already well connected, but they are difficult to scale. How do you get into one when you are not already part of the group? As a result, your ability to do research on companies is limited to interviews and internet searches for lawsuits. As Fowler discovered (multiple times), it’s not possible to do this effectively. To formalize and make whisper networks more accessible, you might need some kind of central agency.

Credit Score for Reputation
Initially Credit Bureaus would form dossiers on people by asking their neighbors and associates about the trustworthiness of an individual. This was subject to natural problems where others could exert undue influence on your ability to gain access to credit. The Fair Credit Reporting Act banned this practice.

Could you have a clearing house for employment verification and reputation from co-workers that doesn’t fall victim to the same problems as those early credit reports? Companies (and employees) may have to agree to do this, and there are natural issues that emerge (libel, coercion, reformation, identity, privacy). Considering Uber was unable to track multiple complaints against the same manager internally, the odds that company would adopt such a service is unlikely.

Who becomes a whistleblower?

Fowler’s prior life experiences from her childhood, her time at UPenn, and other companies prepared her logistically to respond with harassment, to a point where her response to being propositioned on her first day at Uber was almost routine (document, establish a written trial). That’s incredibly sad to think about but her regret from having her research & graduate track effectively yanked from her from no fault of her own at UPenn and not doing something about it is what made it possible to hit “Publish” on her blog post.

Being a good person in Silicon Valley

The primary lesson that living and working in Silicon Valley taught me is that some of these systems are so corrupt, and the only way to succeed in a very corrupt system is to also yourself become corrupt. You can’t be a good person and succeed in a system that is fundamentally broken, that values above all money, power, greed, aggression — Susan Fowler in the SF Chronicle

This quote from an interview with Susan Fowler made think of something that I remember John Vrionis (a VC) once saying (and I’m paraphrasing here): “I deeply believe that it possible to both be a good person who helps others and also succeed in Silicon Valley”. I so hope that he is right.

It seems like we could do with more reminders that it is possible to do both and continue to work towards making that true.

Ultimately, I’d recommend reading (or listening to) the book because Fowler’s story itself is powerful and worth hearing.

View the book


Footnotes:

1) As a side note, the “Op-Eds From the Future” series that Susan Fowler edits at the New York Times is a great read if you are a fan of science fiction.


* Affiliate Disclaimer:
I’m using an Amazon affiliate link here & will donate the proceeds from it to AllRaise. If you’d rather use another retailer, you can find other sellers of this book on the publisher’s webpage.

Getting carried away

What founders and VCs really think about the expose of Away's culture

On Thursday, The Verge posted a long form article featuring quotes from ex-employees at Away (a luggage startup) detailing a “toxic work environment” where employees would be publicly reprimanded, “bullied”, and requests for PTO and WFH would be withheld.

Unsurprisingly this triggered a firestorm on Twitter, where some VCs (but not all) started remarking that they saw nothing really noteworthy here. Other VCs and founders opted to stay stayed silent even though they also felt the same way in fear of retaliation.

Take what happened to Sarah Cone as an example of why VCs are hesitant to voice an opinion.

I’m not here to profess an opinion about the piece, but I am interested in the discrepancy between public statements (or the lack thereof) and private beliefs. One of the books on my reading list is called “Private Truths, Public Lies” which details the consequences of when people are compelled to voice false opinions because of social pressures (a tame example from the book’s description: telling your host at a dinner how great the food is when you think it’s bland).

I thought there was more that people (especially VCs and founders) wanted to say but wouldn’t say so under their own account so I put out a call for thoughts on Twitter.

You can read the full thread here (scroll up to see every tweet). I got around 25 more responses after I closed the thread and I’ve included them at the bottom of this email.

Here’s a quick summary of the most commonly voiced positions from each group:

VCs:

Founders/Operators:

Employees:

Extra Responses

Founder: As a woman of color in tech running my own consultancy, what was sadder than reading the article was reading comments from leaders in tech praising the Away CEO’s “work ethic”. This was yet another disturbing window into the minds of the privileged who fund and run companies in tech.

VC: “I'm annoyed by the VCs and Founder[s] that act as if bullying is necessary for performance or leadership. They need better business role models.”

Operator: Have seen much worse. When the company is successful, this kind of thing is looked upon fondly in retrospect, as a twisted team building exercise, like hazing. When the company fails, everyone recognizes it as the abuse it was.

Someone familiar with Away’s CEO: I don’t think she’s a bad person. Startups are hard, and can create a toxic environment. While I don’t think she is a malicious person, the stress most likely contributed to the behavioral change. It doesn’t excuse her from how she treated her employees, though.

Non Profit Exec: Dylan Matthews' point has stuck with me - startups have co-opted the language of nonprofits and government regarding "mission" to justify long hours, stress, poor pay/benefits. But the "mission" is just...making money.

VC: “I think there’s room to empathize with a first time founder in her 20’s running a business that grew 10x YoY and facing their first real holiday season. There’s also room to say that she fucked up. Her words and actions were regrettable but the whole company rallied against stacked odds. We should be able to commend aspects of [her] leadership while also condemning.”

Founder: “Late night slacks aren’t a problem. Slack mutes notifs outside of work hours by default! Posting in channels about work-related stuff instead of DMs encourages transparency and teamwork and ensures everyone has the information they need to do their jobs.”

Founder: “I wish Crunchbase would tag VC profiles with their reaction to this story so I could filter out the ones I would never, ever, want on my board.”

VC: “For an ecommerce operation CS is really important because impacts margins and reputation. Chronic backlogs like this scream that the org needs to be restructured and that Away needs a new CEO that knows what they're doing.”

Operator: With appropriate disclaimers (I really don't know what their CX did except responding back to emails): for 40k/ year she could have outsourced the CX work to India and would have got about 6 good CX folks to respond to email. Also, 4000 outstanding messages => something seriously wrong with the product or managing customer expectations or BTL messaging.

Founder: “[The article] really was nothing more than gossip/performative bullshit. These stories/hit-pieces serve as a framing mechanism - instantiating the public perception of widespread in-group/out-group bias - and producing an ‘enemy image’ in which to scapegoat/banish/cancel from socially constructed reality. In this case, Steph Korey.”

Founder: “Steph violated Social Justice orthodoxy on numerous fronts - which is why it was necessary to carry out an auto-da-fé against her.”

Operator: “She would have been totally fine if she hadn't sent that slack with the bold emphasis. Bold text is solely the domain of the unhinged”

Founder: “As a woman founder: “Growing at a healthy pace?” Not taking enough risks, not challenging the team; women can’t lead.

“Pushing too hard, toxic culture?” Can’t manage growth; women can’t lead.”

Founder: “If "Values" twisted to justify abuse, employees will also distort values; end result: destruction of co. values: "I will teach you being accountable"=I will fire you if you don't work 90 hrs this wk but no OT, little/no equity. Values=HIRE MORE PEOPLE! Values =/= one way street; good short term cash flow, bad long term”


Operator: “Investor: oh, I like how this founder is so obsessed and will run through walls. I’m sure they’ll work really hard and hire/force people to do the same. Also, [they] explicitly tried to build a cult. Just like Zappos, AmWay, etc- sometime it works but more times it doesn’t. You can’t lie to yourself as an employee and say luggage matters. As a founder, you can. From the beginning, Korey and Rubio were masterful at getting these young employees hyped up about their jobs. “You are joining a movement,” Nope. It’s not a movement. It’s a cult meant to get the valuation pumped through fast growth.”

VC: “That CX team was severely underperforming. A 4 person team should have easily been able to handle that volume, and I’ve worked at a company that did that and seen others.

The CEO was in a tough spot—severely underperforming team in the busy and important part of the year.

I’m sure she tried kindness and inspiration first. And when it didn’t work, what do you do? You can fire the team right before the holidays and hire a team of unknowns. Or you can do whatever to get them actually working productively and not spending all day complaining on Slack.”

VC: “I know the take away from this article is going to be “don’t hire POC” they won’t solve the problems at your company and will blame them all on racism. And that’s terrible […; POC …] are used to doing things under severe constraint and are the most amazing problem solvers that you’ve ever seen. This article was both racist and sexist in the guise of not being that way.”

Founder: “People who respond “sometimes you have to work really hard! that’s a company” don’t appreciate that this problem has no end in sight as “solved” by the CEO and that’s the core issue. Working that hard forever with no exit ramp while being berated by management because they’re downstream of a failing plan = bad management, full stop”

Founder: “ppl chose complaining over quitting. Every top startup is as or more intense. Journalists are jealous of how much money ppl at startups make so the reach for these narratives. Journalists need to be held accountable”

Founder: “the overall feeling I get is that founders are so focused on getting their business off the ground and creating traction they (Away founders) have forgotten that their staff do not have "skin in the game"... They take pride in their work, sure, but they're not the owners. So, the CEOs are expecting a team effort for every aspect of this startup, forgetting that most are there for a pay check.”

VC: “it’s a convenience/luxury product that is not that innovative and may very well encourage an increased carbon footprint from travel. We don’t need Away, it’s not the best use of resources (including the time I’m spending typing this response). I’m sure there’s tons of nuance to this but the Verge story certainly paints Away as the anti-thesis to purposeful business. Now let’s stop talking about Away and do something more useful with our time.”

Founder: “A simple leadership observation: at no point does she ever reference an existing goal and redirect behavior towards achieving that goal. The classic bad manager signal is constantly revising goals in real time as an emotional response to things not going the way the manager would have liked. This is the definition of micro management and it tends to yo-yo staff around because how can you hit a goal you didn’t know you were being evaluated on?Also slack for communicating goals is just lunacy. I completely get it, and am empathetic about how hard it is to become a good manager, but I’m surprised the narrative is [more focused on] how she’s ‘evil’ and [not as much about …] leadership skills.”

Founder: “It’s v bad to threat+pressure people who are already burned. Foolish to do it over chat. Unacceptable to condition vacations/ overtime of employees. I believe the founder got carried away. I hope she recovers. I made mistakes, others were kind to let me redeem myself.”

Founder: “As a founder I struggle managing time commitment expectations of employees. That part didn’t surprise me. Secondly, I have found hard conversations/negative feedback for employees have been far more successful done in a private setting. But hey, something is working over there!”

Employee: “Honestly I see absolutely nothing wrong with the CEO and how she handled things. Her obligation is to shareholders, customers and the board and everything she said was in that pursuit. I think our generation wants it too easy frankly, a leader who focuses on collective friendship and positive feeling as priority no. 1 in the startup environment is not a leader in my opinion.”

Operator: “Away’s exec team obviously had some target of what their numbers would be, months in advance. If you work backwards - fulfillment to customers, trucking to warehouse, ocean voyage, export customs in China, manufacturing and QC, raw material order - the CEO and CFO were likely seeking and approving a line of credit or other debt line to fund the holiday orders in June or July. The production numbers and ramp should have been communicated to every team. And at the end of the day it’s on the CEO to make sure all her teams are staffed up and ready to go. If CX is overloaded over the holidays, it’s not on the agent making $40k. It’s on the CEO and relevant VPs for not having enough agents, enough templates, the right software tools built, whatever”

Operator: “Have seen much worse. When the company is successful, this kind of thing is looked upon fondly in retrospect, as a twisted team building exercise, like hazing. When the company fails, everyone recognizes it as the abuse it was.”

Founder: “What disappoints me most is the bad faith. The assumption from most people seems to be that the CEO and exec team purposely and maliciously attempt to manipulate and control employees at every turn. The base premise is that using slack publicly for transparency is a lie with an insidious "real" purpose of public shame. Of course she fucked up. I fuck up every day. It just makes me sad that so many people are now berating her on Twitter and elsewhere from the starting point of her being a devious sociopath. We should all be giving each other the benefit of the doubt more”

Founder: “Where is Jen Rubio in all this and was Steph doing all the actual work? I find it hard to believe that Jen was clueless in what was going on. As cofounders you’re both complicit”

Employee: “I have no idea how this got more attention than the COO at Riot Games who farted in people’s faces, but VCs clearly won’t care until labor laws are properly enforced & it hits the bottom line”

VC: “I’m a VC... and embarrassed by almost all of the VC replies/takes. There’s a difference between hustle and being humiliating and abusive towards people. I can’t wait until we get to a point when people don’t excuse assholes or asshole behavior for business execution or ambition for a world leading business”

VC: “Core problem here was clearly ops & process, not culture. Not enough automation / efficient triaging of basic CX interactions, not right team mix (more offshore, obviously, but also why hire in NY where a $40K salary = poverty & constant anxiety?), not enough team members overall, poor communication between Ops & CX. Founder was solving core ops issues with elbow grease & shame.”


A quick side note: I think Sriram is correct that this a type of conversation that needs a special experience to enable and that it needs to be carefully curated (since anonymous social products generally tend towards chaos/lawlessness). I share the desire that people would openly be able to share their thoughts here, but the reasons that they won’t are clear.

Understanding VC Doublespeak

In this world, speaking clearly is a Narrative Violation

Whenever a VC tweets about how “thrilled” they are about something, I always think about some poor soul out there who might actually believe that said VC is genuinely “thrilled” that the VC’s college roommate decided to take a VP of Product role at some hot startup.

Here’s a handy chart to better understand VCs and the euphemisms involved.

Of course, not all VCs think this way. Some of them pride themselves on thinking differently. For those VCs, you’ll find this chart to be helpful:

Happy Holidays! May your holidays be filled with carried interest and narrative violations!

How VCs Make Money

Digging into "Two and Twenty" & VC compensation

Money, money, money. Always sunny. In the [fund managers's] world — ABBA

If you have ever been inside a VC firm’s office, you’ve probably seen a few things that seem excessive. It can range from a bee apiary on the roof to meeting rooms featuring tables that seem unnecessarily long [and expensive]. Some of those live-edge tables alone can cost over $20,000. Once you understand how VC firms make money, it becomes clear why firms can afford to buy those tables for their fancy offices on Sand Hill Road (home of the most expensive commercial rental space in US)

Two and Twenty

If you ask most VCs to describe their fee structure, most will say, “2 & 20”. That term describes a 2% management fee on committed capital and a 20% profit-sharing split as carried interest. The management fees and carried interest are fees that the Limited Partners (the institutions or people providing most of the money for the fund) agree to pay to the VC firm as compensation for finding investments and administering the fund. Like many other structural parts of VC, this standard for fees was imported from hedge funds and private equity firms.

Chris Harvey has a good list of the standard terms on a $50M fund. We’ll dig into the mechanics of each the of the terms below.

Management Fees — The Two in “2 & 20”

The management fees are used to pay for salaries, rent, travel, marketing, software, swag (like Patagonia jackets), and events like the annual LP meeting.

The catch that many people outside of venture miss is that the management fee is charged every year of the fund’s life (which is usually around 10 years long). That means that a standard fund will charge 20% of the fund’s total raised capital in guaranteed fees and can only use the remaining 80% to actually invest in companies. A good rule of thumb is that for every $1 a LP provides, only about $0.80-$0.85 will be invested.

Every time you hear about a new fund that raised a billion dollars, keep in mind that around two hundred million dollars will go to the firm for “operational expenses and compensation”. Most funds are only actively making new investments for two to three years and for the rest of the time the fund is in maintenance mode. Do you need $200M to operate a twenty person firm for four years and to keep the lights on to make follow on investments for the next six years? Not really.

These economics change when you have a smaller fund (say, under $30M). These funds typically charge 2.5%+ since many of the operational costs of running a fund are somewhat fixed regardless of fund size. If you have a fund under $10M, you aren’t going to be making a lot of income on management fees after accounting for fund expenses and overhead. Alternatively, some VC firms choose to front-load the management fees during the period that the fund is actually investing by charging a larger percent on the capital pulled from LPs during the first three years and then charging a correspondingly lower percent for the last seven years. We will dig into capital calls in another post, but when it comes to management fees, the fees are calculated based upon the total committed amount to the fund, not just the cash that the fund already has in the bank.

After accounting for cash left aside for follow on investments (usually around half of the investable cash), VCs only end up deploying ~40% of the total amount of funds they raise into new investments.

Some VCs also charge their portfolio companies for legal fees that the firm incurs during the process of investment. The investment documents set a maximum amount that the firm can charge the company for legal fees. In what can only be explained as a coincidence, the actual legal fees incurred always seems to hover around just below that maximum amount. It is almost as if the lawyers have figured how this system works and how to maximize their billable hours. VCs can use the proceeds from companies to reimburse LPs for management fees. There are a few firms (like K9, Afore, and Homebrew) that have committed to not charge companies for the fund’s own legal fees in a round. VCs will argue that the company should pay since the legal and due diligence fees are shared among all the investors in the round, but it is hard to deny that the status quo is an inefficiency that legal firms have efficiently squeezed into.

Carried Interest — The Twenty in “2 & 20”

While guaranteed fees like management fees are nice, good VCs make the real money on their performance fees taken in the form of carried interest (known as carry). Legend has it that the origins of carry date back to whale hunting expeditions where the crew could take a portion of the proceeds for themselves, specifically whatever they could carry off the boat after returning.

Similarly, the general partners of a VC fund are entitled to receive a percentage of the profits of their investments as carried interest (usually only of the proceeds after the VCs return the original capital contribution of the LPs).

For example, if the fund raises $100M with the standard 2 & 20 fees, and turns that into three times the original capital $300M (from $80M of invested capital assuming 2% management fees). VCs are entitled to take 20% of the $200M they generated for the LPs. That comes out to $40M of carried interest for the VC firm, which is taxed as capital gains (and almost certainly long term capital gains since returns in venture take much longer than the three year threshold that Congress recently set for carried interest).

After accounting for Management Fees on this 3x hypothetical fund, LPs end up paying around $60M in fees to a firm with only a few partners. The firm now has to divvy up the b̶o̶u̶n̶t̶y̶ well deserved performance fees among the partners. The specifics of how this is done depend on each firm. Many times the partners that brings in a deal gets a larger chunk of the carry on that deal. This unequal split & attribution issues are a root cause of the intense politics that happens within the partnership to claim credit and pound the table for your own deals. The exception is to divide carry equally among the partners involved with each fund. Some of the best firms, including Benchmark, do equally split the carry among partners.

The logistics of when VCs receive cash from exits depends on the terms and is usually modeled as a waterfall. There are two schools of thought for this calculation, namely the “American Waterfall” which favors GPs and the far more popular “European Waterfall” which favors LPs.

The “American Waterfall” where carry is distributed on a deal by deal basis and may be clawed back from VCs at the end of the fund if it doesn’t return enough capital overall. With the “European Waterfall” capital has to be returned to LPs at a fund level before carry is distributed. In this model, GPs only get carry once all of the original capital is returned to investors and any additional return requirements are met. This requirement means that VCs will not get paid carried interest until they return the fund, which could take six to eight years.

Even though VCs and LPs expect funds to 2-3x at a minimum, many VCs don’t hit this threshold, so the firm mostly just pockets the management fees.

As long as VCs can continue to raise from new funds LPs, they get another shot. Because VCs raise a new fund every two to three years, the return profiles of their old funds are not always clear. LPs are inclined to stick around with VCs for a long time, because of their own FOMO (fear of missing out) on a particularly great vintage (the year in which a fund started making investment).

For the funds with exceptional returns, the partners might be sitting on generational wealth through their carry. As of last year, Benchmark’s 2011 vintage (their seventh fund) was famously sitting on about $13.5 billion of returns (a value of $14B on $550M invested). There were seven partners on that fund and depending on how much carry Benchmark charged on that fund (likely 30%), each of the partners are potentially taking home about $400M-$600M in carried interest (before taxes) as those positions exit. Those are numbers that make many traditional private equity and hedge fund managers jealous. And that’s just from one fund, VCs raise new funds every two to three years.

Once a fund reaches the end of its designated life time (10 years), it can be extended for a little bit to allow companies to exit, but VCs are pressured to get their stakes to be liquid so that they can capture the returns (and carry) as well as close out the fund to longer pay the administrative cost to keep the fund running. If their ownership stake has been written down and they don’t see an exit anytime soon (“impaired” in VC parlance), VCs may just write off the investment or sell the stock in a secondary transaction.

Bonus: “Fund Expenses”

In addition to charging LPs management fees, VCs are entitled to use some of the fund’s own capital for costs that are incurred to actually raise and administer the fund (for example the formation fees for the actual fund and certain audits). Now you might wonder, isn’t this exactly what management fees are for? You could make that case, but VCs and LPs have an agreement (the Limited Partnership Agreement) that can spell out what can and cannot be charged to the fund) and a hard cap on organizational expenses for setting up the fund.

“But what about Fee Recycling?”

VCs reading this might dismiss their notion of them charging high fees by saying that they “recycle management fees”. What that means is that instead of immediately pocketing their management fees, a chunk (or all) of it gets to be used for investing in companies (typically in follow on rounds of existing portfolio companies).

VCs are still entitled to the same chunk of fees but they are just issuing a free loan to their LPs in exchange for hopefully getting more carry and getting the original fees back later. It aligns incentives better, but at the end of the day it is essentially just a way to get a larger effective fund size without asking for more capital from LPs. If you are a good investor, this will result in better returns for everyone, but it’s not really cutting into the fees that VCs charge , recycling merely delays those fees.

It pays to be a winner: “3 & 30”

For the firms that consistently produce great returns (think Sequoia and Benchmark), LPs are constantly competing to get an allocation because those funds are likely to continue to produce good returns (because of “The Top Quartile VC Loop”).

If you’re able to get into Sequoia’s fund (which only accepts non-profit LPs) or Benchmark’s funds you aren’t going to quibble about the higher fees they charge because you can be more confident that they will have superior performance (thanks to their established reputation) and that even getting an opportunity to invest is scarce.

These top tier funds often charge a higher fee, “3 & 30” (3% management fee and 30% carry) or even higher but their performance justifies the fees. In venture, the best firms generate a lot of the returns, so their fees are worth it. Sequoia could charge more and still oversubscribe their funds, but they’ve decided to only accept non-profits for their LPs, which conveniently serves as a way to limit demand.

If you asked an LP to choose between Benchmark’s high fees and some third tier VC for zero fees, they’d go with Benchmark each time. For LPs that don’t have access to top tier funds, they often even pay a second level of fees to managers that pool money from LPs to invest in venture funds. These funds are called “fund of funds” and often layer an additional layer of 1 & 10 carry. If your choice is between a third tier no name fund with mediocre results or a fund of fund that can get into good funds, the choice is clear despite the additional layer of fees.

If you want to hear about exorbitant fees, Renaissance Technologies (a hedge fund) had a fund that generated ~71% IRR pre-fees but would charge 5 & 44 because they couldn’t support a larger fund size (to match the returns after fees your bank would need to give you an annual interest rate of 56%).

Why don’t LPs demand lower fees?

  1. “Venture is the only asset class in the world where the asset chooses the manager and not the other way around”. Finding people who can do venture well is difficult

  2. “2 & 20” (or more) is the standard practice among many asset managers (though it is falling out of favor in other asset classes)

  3. LPs are understandably risk averse about changing fee structures given their obligation to responsibly allocate their institution’s capital.

  4. You don’t want to develop a bad reputation with GPs who may prevent you from investing in any of their future (potentially high performing) funds.

  5. Once an LP back a funds, they are inclined to almost automatically commit for a few more funds with the manager to track performance.

  6. In theory, the fees won’t matter if VCs out perform the benchmark.

For a deeper look into why LPs even invest in venture, I’d recommend Scott Kupor’s latest book, Secrets of Sand Hill Road.

Carry Hurdles

LPs can sometimes insist on a certain rate of return (known as a carry hurdle) before VCs can take carry so that they can ensure they get a sufficient rate of return (around 8-10% per year) on their own capital before VCs start dipping their hands into the profits. If a fund is using the “American Waterfall” model for carry calculations, GPs get carry when a specific investment exits (if the return rate on that investment meets the hurdle) but if when the fund closes the overall fund level returns do not meet the hurdle, the carry that was distributed can be clawed back. If a VC happens to have used that cash to buy a mansion in the Hamptons, they probably be making a call their real estate broker.

Carry hurdles also allow VCs to charge more in carry if they outperform expectations. The math isn’t particularly interesting, but the salient point is that there are some limitations that LPs can impose on high fees and ways to charge more if the fund out performs.

Management Companies & Salaries

If you’re a partner or managing partner at a large firm ($750M+ AUM), you’re probably making somewhere between $350k and $500k in yearly compensation. It’s not a bad gig but again that’s not where the real money is. It’s in the carry (as usual) and in the ownership of the underlying management company. What goes unsaid, is that only the actual partners in the fund get any carry, associates just get a comfortable salary and the prospects of becoming a partner (at another firm obviously)

The management company for the fund is the entity that actually receives management fees. It pays out salaries and certain expenses for running the fund. Anything that’s left over is kept for the management company and is distributed to the owners of the management company as profits. Doing some napkin math on a firm with $1B AUM, the management company receives $20M each year in management fees. After some generous assumptions, for a fund with a staff of 22, they’d spend around $10M to operate the fund every year. The ~$10M of profit goes to holders of the management company (which usually comprises of a few key GPs of the fund and the founders of the firm).

As the founders of firms retire, they can continue to keep a portion of the management company and receive their chunk of profits despite not being involved in day to day operations of the new funds. When there is an acquisition of a VC firm, the actual asset being acquired is the management company and the brand. You could build a solid business solely by acquiring the GP stakes in management companies and funds; unsurprisingly, that is what some large firms like Goldman Sachs and Blackstone are looking to do (though mostly in the world of PE).

Being a VC is not all high salaries and nice perks though, if you are an actual carry earning partner in a fund, you do need to pony up some of your own money as part of a what’s called a “GP commit”. LPs usually require the partners to contribute 1-5% of the total fund size using their own money. This helps align incentives but also isn’t enough of the fund that VCs would be too conservative with their decisions. Typically this is usually 1-2% of the fund. So if you are raising a $250M fund, the partners are expected to contribute (in aggregate) $2.5M to $5M. If a partner doesn’t have the kind of cash to pay their commit up front, either they can get a personal loan from a bank or have the fund offset a corresponding amount of management fees in lieu of a commit. Banks frequented by VCs like SVB have specific offerings for this kind of lending among other lending products (like helping funds borrow capital to deploy ahead of an official capital call)

VC is not the path to riches

It might sound like being a VC is a great business, and it can be, but it’s filled with pitfalls. If your goal is “change the world” and/or "build obscene amounts of wealth”, you are probably better off building a company than becoming a VC because many VCs don’t make much money beyond their salary. The open secret is that to become a VC it helps to have acquired some money beforehand (to pay your GP commit among other things).

Meanwhile, for those of you hoping to score a fancy live-edge table, you will need to hope that you can manage to catch the VC firm’s office manager selling off their old tables on Craigslist when the firm upgrades to an even fancier table

Acknowledgements

Special thanks to @ChrisHarveyEsq, @MasonNystrom and @TurnerNovak (among others) for reviewing an early draft of this.

If you’re interested reviewing future drafts or have suggestions for future posts please … let me know how I can be helpful on Twitter: @vcstarterkit

What happens when you turn $1m into $750m as a Junior VC

The answer will not surprise you + Last week in VC (9/16/2019)

As a VC if you end up leading an investment into a company that ~750x’s and returns the fund, you might expect a piece of the carry or some kind of thank you, but if you were a junior VC when you led that investment, you’ll likely never see anything other than the GP’s new mansions in the Hamptons on Instagram.

It’s a side effect of how junior VC roles are usually structured (a nice salary package with no carry and limited prospect at promotion). You get none of the financial upside (carry) and marginally lower downside.

If an investment works out, it’s because the partners approved it (or a partner will try to share/take the credit). If it doesn’t work out, the partners get to diffuse the blame: “it’s the associates fault — they are still learning after all”. To be fair, not all firms/roles are like this, some firms let associates invest their own money into a sidecar vehicle.

Disclaimer: I haven’t verified what @arrington is hearing, but it shows a completely plausible scenario

Last Week in VC

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