Documentation / Venture Capital

Capital Budgeting

How to budget for invested capital and fees in the venture fund models

A common mistake made in modeling venture funds is to assume the entire fund size in invested, not accounting for management fees and operating expenses charged to the fund. Creating a capital budget that accounts for these expenses is vital to understand the economics of a fund.

Committed Capital

Committed capital is the total amount of capital that has been committed to the fund by the limited partners (LPs), and this is used to invest in companies, pay management fees to the management company, and pay fund operating expenses.

The simple way to think about calculating investable capital is:

Fund size (Committed Capital)
- Management Fees (management fee % * number of years * committed capital, or assets under management, etc.)
- Fund Expenses (fees charged to fund for fund formation, legal, fund administration, audit, tax)
+ Recycled Capital (most commonly, if recycling management fees)
= Total Invested Capital

Committed capital may be set in a single close, or in multiple closings of the fund over a year or so.

Management Fees

Management fees are paid by the fund to the management company to pay for managing the fund. These are revenues to the management company, and the the intent is for these revenues to cover the manager’s expenses in sourcing and supporting investments (salaries, marketing, etc.).

Of the “2 and 20” model, management fees are the “2”, typically expressed as a percentage of total capital that is charged per year the fund operates. It's important to note that even though it's called "2 and 20", meaning 2% management fees and 20% carried interest, the "2" is charged per year of the fund life, so for a 10 year fund, 2% management fees in total would be 20% of the committed capital.The percentage can vary over time, and it would not be unusual to have it be higher during investment deployment period, and decrease over fund life. Management fees are typically charged and paid quarterly along with quarterly capital calls. [1]

Note, multiple closes will not change total fees, later investors will “catchup” on fees to be on same cost basis for investments.

Calculating Management Fees

There are a few different ways to calculate management fees for venture funds. A 2% annual management fee, for example, can be charged as:

  • 2% * total committed capital
  • 2% * called capital, using total called capital at the end of each quarter or period
  • 2% * assets under management, using total invested capital at end of each quarter or period. Invested capital will include investments made, less any exited capital or writeoffs, and will not be full market value of investments.
  • A mixure of the above, with some years charging a percentage using one base, and a different base for other years. A common approach is to charge based on committed capital during the new investment period, and then charge based on assets under management thereafter.

In addition, the percentage charged can change over time, for example charging 2.5% for the first couple years, then scaling down over time, perhaps such that the total fees are still 20%.

Forecasting total invested capital when the fund is charging management fees based on assets under management can be challenging to model.

Calculating Recycling

Recycling allows investors to invest more capital, a simple goal that is commonly misunderstood. Consult Recycling for details on how recycling works.

Calculating Expenses

Many expenses can be charged to the fund in addition to management fees. There are two basic kinds:

  • Organizational expenses are one-time fees per close of capital, typically legal and closing fees
  • Operational expenses are ongoing expenses paid by the fund, in addition to management fees, typically including fund admin, tax, audit, fund legal

What expenses can be charged to the fund and what to the management company is covered at Management Company.

  1. Rolling funds work differently, as total management fees are charged upfront for each quarter's fund close, held in escrow, and then paid to the management company on a pre-determined schedule. ↩︎