Using VC management fees as book value contributions, not expenses.

Investors in Venture Capital (VC) funds generally must accept on average 2.0% - 2.5% management fees, as indicated by the Carta Graphic above. These are yearly fees used to pay for the ongoing operations and management of the fund and reduces the amount of capital available to be invested into the fund's portfolio companies, generally by 20%. In other words, for every $100 of investment, $80 is actually invested into associated portfolio companies when considering a 10 year fund, with the other $20 going to fund management (ie. with some funds spending even more on fund operations and management, leaving even less for investment).

Less investment available into portfolio companies means:

• Management fees ultimately reduce the potential returns for investors. Cambridge Associates calculated that the average fund return multiple on the amount of capital raised (ie. also known as Total Value Paid In or TVPI) is 1.5x in low years to 4.5x in boom years. This means for every $100 dollar invested, an investor earned $150 in low periods to $450 in high periods. However, if there were no management fees, those same fund multiples could be 1.88x - 5.63x (ie. investor receives $188 to $563 for every $100 invested), certainly a welcome boost for the investor and fund manager, especially in tougher return periods.
• Additionally, management fees increase risk of obtaining returns. Only a small percentage of portfolio investments in a VC fund actually generate a positive return, typically around 20% or less of the total portfolio companies. Thus a fund that is targeting 20 investments could have done 25 investments without management fees, which would have likely enabled at least one more investment into a portfolio company that generates returns.

While the 2% - 2.5% fee structure is the long-standing accepted approach to venture investing, are there better alternatives? At Holt Xchange, we've experimented with numerous business models and process innovations. When it comes to management fees, we believe there's a way to essentially have no management fees, or better (ie. earn assets equal or greater to the management fee expense, outside of assets associated to investment), while also providing greater portfolio support.

In our first 5 years of operations for Fund I, we ensured our team and processes were geared towards generating value for our portfolio companies, and while this resulted in added costs, we obtained some form of assets in return for these added costs. This included tangible assets like added equity stakes for our efforts, equity in exclusive oversubscribed deals, as well as cash in the form of revenues from partners who aligned with our processes. It also included intangibles like great relationships with our founders ensuring better information rights.

As our fund was smaller than many pre-seed / seed funds, this meant that our expenses relative to assets under management appeared at surface-level quite high (ie. expenses as a percent of our fund were 60% during this period, opposed to industry assumed 10% to 12.5%); however, when accounting for added equity stakes in companies, as well as revenues obtained from corporate partners for shared objectives (ie. access shared venture scouting, event sponsorship, etc.), and government grants received for digitizing our processes through the use of AI, our fund actually earned $161 for every $100 dollars an investor had invested into Holt Xchange versus the $87.5-$90 for every $100 dollars an investor obtains under a traditional model during the same time period.

Spending 60% of admin fees requires extra attention to cashflow management. This is especially true considering the delays in cash flows received from corporate revenues (ie. short-term delay), grants (ie. medium-term delay) and distributions (ie. longer-term delay). Additionally, there are many remedies to ease cash flow constraints including reducing / removing scheduled investment contributions from our investors (ie. investments are one-time up front versus yearly instalments over a set number of years), and/or reducing initial investment amounts into portfolio companies while maintaining strong follow-on investments capabilities.

While some of those dollars earned went into to develop our own technology to better deliver our services at scale (which also increased our book value), we estimated that we were able to invest into 65% more companies versus a traditional model. Given that the general consensus for very early stage venture funds (pre-seed / seed) is to construct a portfolio of +30 companies so there's there's sufficient number of companies to reach Series B and beyond, our model enabled our fund economics to work well especially considering our comparatively smaller Fund I size.

Thus our unique approach = more upfront expenses < greater equity shares in a larger number of portfolio firms. The biggest contributor to these positive economics under our fund model was negotiating extra equity alongside our investment for the value we provide into top ventures. While this approach has been somewhat normalized from the success of for-profit accelerator funds, many cookie-cutter existing investment templates hinder more advanced teams from choosing to participate. To counter such objections, we were flexible in our terms, and established open discussions about the value we could provide, the associated cost of this value, and how that cost would convert into each company's respective valuation. While this made for a longer and more intense negotiation process, it also better aligned each of our expectations prior to arriving at a deal. Additionally, more advanced ventures that wouldn't accept other world renowned accelerator terms were very amenable to our flexible terms, especially considering our sectorial focus and network.

The biggest reason why we were able to continually derive these terms was the proven value our teams received on average. We spent a lot of time on building a curated network for each of our portfolio companies, resulting in over 100 deals closed between our network and portfolio companies. This was in addition to other table stakes items like partner level strategy meetings, associated partner discounts and grants worth hundreds of thousands of dollars, as well as visibility across various in-person events and online forums.

As the model for Fund I shifted into purely making follow-on investments, we continued to see opportunities to support our investments while our book value through asset generation. This included managing Special Purpose Vehicles (SPVs) on behalf of selective portfolio companies, which essentially enables us to raise capital for them while ensuring we get some upside (ie. fund carry) for our efforts.

In addition, we've worked with Exempt Market Dealers (EMDs) who are licensed dealers that are allowed to charge success fees, enabling us to obtain assets including warrants for successful efforts in capital raising for our portfolio companies. These methods are important workaround as the restrictive fundraising rules in North America hinder charging for successful referrals.

This model has the added benefit of ensuring our book value increases, given our investment in the 'client' portfolio company increases, as they raise their next round of financing. Thus breakout companies raise more quickly, potentially accelerating our time to obtain returns, and/or ensuring they close their much needed capital, potentially reducing risks of asset write-offs.

In a venture capital world where capital flows less freely, company valuation multiples have been recalibrated downwards, and investors become ever more selective. A fund that proves it adds value to its portfolio through shared success and that optimizes expenses to drive more returns, may be what's needed to attract investors' capital.

After all, if we aren't in the VC game to support our portfolio, while maximizing returns for investors, why are we in it at all?