For a myriad of complex legal reasons, Limited Partners require General Partners to contribute their own capital into their venture capital fund. While this amount can vary, the vast majority of the time GPs need to contribute 1% of the committed capital with LPs contributing the remaining 99%. Thus the 99/1 rule.
The depth of an venture capitalist or private equity investor’s “J curve” is typically 3 years. In good times (such as 1999) it can be as short as 1 year. In bad times (such as 2002) it can be as long as 5 years…or infinite. A “J curve” is the graphical representation of the value of a portfolio of illiquid investments over time. For example, in the first years of a venture capital firm’s new fund, they are deploying capital at cost and collecting management fees. Therefore, until they have a reason to write up the value of their investments (follow-on funding at higher valuations) or a liquidity event, the value of their fund is lower than the capital contributed. So, the depth or length of the “j curve” is the length of time that a funds value is less than the capital contributed.
As a general rule, firms will only raise an inside investmetn round if they cannot raise an outside round. An inside round means that the entreprenuer only raises capital from the investors in the previous round. This situation raises a serious conflict of interest around the valuation of the round since there is not any objective 3rd party to set the new valuation.
Fund of Funds typically receive a 1% management fee and 5% carry (or carried interest). Since funds of funds are much more scalable than a direct investment fund, they can charge a lower management fee and carry and make up the difference by quickly deploying the committed capital and raising another fund. This allows them to quickly amass a large amount of capital under management and thus earn significant management fees.
The General Partnership (GP) of a venture capital fund typically receive to types of fees for their investment services:
Private equity funds (including venture captial funds) are typically structured to be “self-liquidating”. This means that they dissolve at a pre-determined time, which is typically 10-12 years after its founding. However, if the fund is not fully invested and/or liquidated by the pre-determined time, the Limited Partners generally grant an extension to the General Partners.
Private equity buyout valuations have historically averaged about 4 to 5 times EBITDA. In recent years (2005 and beyond), private equity buyout valuations have been closer to 10x EBITDA. Insiders agree that this will limit Private Equity (PE) returns to mid- to low teens in sharp contrast to their historical 30% IRRs.