What’s the business model behind (operating) VC firms?

Recently, we have dug into the questions on working capital for emerging VC and PE fund managers. What we found surprised us. Turns out, there are many more options available than most fund managers think about. Here are the 12 categories you can use to fund your next VC or PE firm.

Christian Rangen, Strategy advisor to investment firms, family offices, ecosystems, governments and companies Run multiple GP Accelerators, Masterclasses and teach VC at leading business schools globally. Chairman/GP Link Capital, Energy Transition Fund

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Most VC & PE firms have the classic 2& 20 business model. 2 % management fee on capital and 20% carried interest on proceeds above the target threshold. On the surface, this is the industry standard. But, for many firms, both smaller funds and emerging fund managers, this business model does not work well. Either the assets under management is too small to carry the full operating cost or the fund has yet to get to the infamous first close, upon which time the fund managers can start doing capital calls and pulling down management fee to fund themselves.

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Over the past years I’ve worked with more than 250 such VC/PE funds around the world, everything from year-long relationships to one-day teaching sessions. Notably, I’ve had the chance to work very closely with 28 funds to date through the 2X Ignite GP Sprint, a 6-month emerging fund manager accelerator, for funds investing with a gender-lens. The large majority of these 250 funds all point to the challenge of working capital. “How do we fund the operations, the hiring, the fund raising, the day to day, before we reach first and final closes?”

More recently, this question has kept coming up in coaching sessions, workshop and masterclasses, increasingly prevalent. Speaking with all these talented managers, we started realizing two things.

1.????? Solving for working capital challenges is a task that needs much more attention

2.????? Already, there are many – and many creative – ways of solving this challenge

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So,? a few weeks ago, we went to work, starting to interview experts in the field and fund managers building new VC and PE funds as we speak.

What we found surprised us. There are actually many more ways to fund your GP working capital than we had first expected and anticipated.

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Here is what we found

12 categories and 35 ways to fund your GP Working Capital

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We identified 12 unique categories of working capital, some of them industry standard and obvious. Others, far more exotic an creative. Next, we identified a total of 35 different ways to fund the working capital. No single firm would ever want to use all 35 ways, in fact some of them would effectively block or prevent each other. But we did find that most firms did in fact combine many of these, frequently putting 5-,6-,7- or 8 ways together for a patchwork of GP financing.

Of course, for larger, established firms with large AUMs and long operating track record, this maybe won’t be necessary, but for emerging managers and smaller funds, a patchwork of funding options are indeed required. yet, we do suspect that even larger firms, as they grow their AUMs, will continue to deploy a patchwork approach, simply because it allows them to fund more people and run more services, activities, research and platform support for their portfolio companies.

Here's how to fund your GP working capital

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1.????? GP Cash & Credit Cards

2.????? Grants

3.????? Loans

4.????? Equity Investors

5.????? Sponsors

6.????? Program Fees

7.????? Convertible Structures

8.????? Creative Fund Economics

9.????? Deal Fees

10.? Deal Advisory

11.? Operating Roles

12.? Consulting

Note, some of these will be frowned upon, some may even be prevented by the legal setup in the LPA (Limited Partner Agreement), but each of these have been found in the GP/expert interviews recently.

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Introducing the GP Working Capital Map

To make it easier for people working in the field, from GPs, LPs, faculty or anyone interested in the topic, we created a dedicated Strategy Tools Canvas – the GP working capital map (part of the 100+ Strategy Tools VC Canvas Series). Download the GP working capital map here.

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?Zooming in on the 35 detailed ways

1.????? GP Cash & Credit Cards

Of course, the easiest way would simply be for the participants in the GP, the Partners of the fund, to pay for this themselves, out of their own pockets. Most do, for the initial setup, but quickly realize their personal savings will run out far faster than they will reach first close on the fund.

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1.1? GP Initial Funding

GPs put in the initial cash, for setting up the firm and basic legal structure. Amounts can vary from $50.000 to $1M, or more. Many managers seem to have

1.2? ?GP Commitment

Meeting the GP commitment is a function of % and the fund size. While this capital is dedicated for investment purposes, it can be creatively cycled through the system and used for covering (large parts of) working capital. See point 8, Creative Fund Economics.

1.3? GP Loan

My good friend Rick Rasmussen once said, “every fund manager, at some point, will need to loan money into the firm to get it off the ground”. A GP loan is a short-term, personal loan from the partners into the operating side of the business.

1.4? GP equity investment

As the firm grows in size, more capital may be needed. In those cases, the partners can do an equity investment into the firm, simply adding more capital, like you would in funding any operating business. This can cause some issues, if the partners have very uneven access to capital here.

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2.????? Grants

In many parts of the world, grants for emerging fund managers are available in the market. Receiving a grant may require a highly competitive application process, but the option is out there.

2.1 Local Grants

Local grants are often tied to very specific, local ecosystem initiatives.

2.2 National Grants

National, or federal grants usually sit within a larger, national VC ecosystem strategy. “We seek to triple the size of our VC industry, and this is one of our key federal tools to making that happen”.

2.3 International Grants

International grants are typically funded by large international organizations like Ikea Foundation, KfW, VISA Foundation and Mastercard Foundation and similar. Also known as (one form of) catalytic capital or (one form of) technical assistance, an international grant can be a big boost for an emerging fund manager.

2.4 Repayable Grants

Conditionally repayable grants are grants, to be paid back only in the case of a successful first or final close. Provided by multiple agencies, foundations, DFIs, funds and projects, like the SDG Impact Finance Initiative, repayable grants can be a key funding source for emerging managers.

3. Loans

Loans can be tricky structures to work with for fund managers. In some cases, any loan facility may be heavily regulated in the LPA. Yet, loans are both common and quite easily accessible for fund managers.

3.1 High-risk Loans

From local lenders to high-interest banks, there are multiple potions for high-risk, high-interest loans. Yet, these options come at a high cost and may not be very attractive to most firms.

3.2 Bank Loans

Most banks are not familiar with the economics of a GP structure. Most likely, your bank is not comfortable providing loans to your GP. But, we have seen several examples of VC ecosystem connected banks and financial institutions providing working capital loans to GPs.

3.3? Convertible Loans

Convertible loans are most likely to be provided by personal connections, angel networks and High-net worth individuals, possibly also family offices. See also point 7 below.

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4. Equity Investors

Often frowned upon from DFIs, bringing in strategic, equity investors can be a great way to fund the early years of a new investment firm. At later stages, when successful firms have grown large, seeking a public listing is a great way to attain liquidity, secure capital and overall grow the firm. For most emerging managers, seeking equity investors for fund I, II or III can be challenging, but far from impossible.

4.1 Equity investors into the top companies (in the structure)

A successful firm may be able to attract supportive, strategic investors to buy into the top company in the structure. PE giant HitecVision has numerous very happy investors, having backed the firm (not the funds) in the early days of building the company. Similarly, the world's most active investor, Antler, has also raised money from outside investors for operating and building out the early days of Antler.

4.2 Significant anchor investor

UK-based Thema, founded by seasoned GP/LPs Sam Ettelaie (ex-British Business Bank) and George Askew (founder-turned-VC) are seeking to be the first ticket in with first time fund. Thema can bring ￡5M in LP funding and provide a wealth of expertise, network and fund setup experience. In return, Thema takes 15% - 20% stake in the management company, effectively acting as a significant anchor investor (with a pre-arranged option for the GP to buy out Thema at some point).

5. Sponsors

Sponsors are unlikely to directly sponsor the fund or the management company, but the right sponsors can fund specific events, conferences, reports or research. An entrepreneurial firm will be able to integrate these elements into the platform (overall service offering of the firm).

5.1 Events

Fireside chats, exclusive meetups, high-powered CEO forums; corporate partners, law firms, placement agents, financial advisors and banks are often willing to sponsor events aimed at the right audiences.

5.2 Conferences Lithuania climate tech vc firm Contrarian Ventures is widely known for their working building and running the Energy Tech Summit. Held in Bilbao, the event is one of Europe’s leading climate tech conferences (and so much more than just a conference). Energy Tech Summit is a large part of the platform – and funding – at CV.

5.3 Reports

In December 2023 African climate tech accelerator, Catalyst Fund, published the report, Investing in Climate Tech Innovation in Africa. The insightful,51-page report was supported by FSD Africa, UK International Development, UNIDO, GEF, and JPMorgan Chase.?

5.4 Research Dubai-based Global Ventures has published a number of research-reports on key sectors in the UAE. From fintech to Healthtech, energy and agritech, these thoughtful research documents are prime for one or more strategic partner to sponsor.

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6.?Program Fees

While off limits for some, running startup support programs is a core part of the value-add for many early-stage funds. From standard accelerator models, scale up programs, founder circles, to more rare paid angel networks and education programs, the category offers multiple interesting financing options for the entrepreneurial-minded GPs.

6.1 Accelerator Program

One of the most tried and tested funding models in this space, the accelerator program allows early-stage funds to invest, for example $150.000 or $250.000 for 7% equity, and then recoup 25% - 50% of that investment in program fee, paying for the accelerator team and mentor network it brings. Globally, 1000’s and 1000’s of startups go through this model every year, in the process allowing emerging fund managers to build more sustainable operating models. ?Notable examples include 500, Y combinator, impact accelerator Katapult and Hatch Blue Aquaculture accelerator.

6.2 Scale Up Program, ecosystem building programs, ocean MBAs, corporate innovation services, emerging fund manager programs

Following the accelerator model, scale up programs are more customized, oriented towards more later stage growth companies and are typically shorter in duration. These programs, with the right level of quality and relevance, can be a core part of a GP platform offering, and a successful paid service for companies. Some firms also explore ecosystem building programs and corporate innovation services. While legally and organizationally separated from the fund, these corporate innovation services form a key part of a firm's larger platform.

One such example is Hatch Blue, the global aquaculture accelerator. Now operating three legs of its business model, Hatch runs multiple (3) early-stage funds, multiple aquaculture development programs in places like Hawaii, Singapore and Ireland, while also offering aquaculture innovation services to global clients (disclaimer, I've been a friend, fan and paid advisor to Hatch since inception). Many emerging managers could learn from following Hatch's entreprenurial growth model in pursuit of their sustainable VC business model.

US-based Propeller Venture offer their pipeline and ecosystem an intense Ocean Mini-MBA, in collaboration with MIT, Woods Hole Oceanographic Institution and HubSpot, and sponsored by Goodwin Proctor LLP.

Another example, on the horizon, is the rise of VC-led GP programs. We are starting to see a number of GP training and development program, including GP accelerator programs, led by other VC funds. One interesting example is Speedinvest working with emerging micro funds, where they added 17 new micro funds in 2023 alone. We expect this number to continue to grow into 2025-2026. While still early days, this is yet another way of offering programs at the GP level.

6.3 Angel Network

As they have grown from an $11,5M fund I, into significantly larger funds II and III, Hustle Fund has kept adding sources of revenue to finance the platform. Hustle Fund Angel Squad is one such example. Today counting 1500+ members, with a goal of 10.000 members, the Hustle Fund Angel Squad members pay an annual or quarterly fee to be a part of the squad, enjoy the dealflow, co-investing opportunity, learning and network it brings.?

6.4 Education

In recent year, 500 Global has stepped into education in a big way. Today, 500 Education offers a wide range of programs for VC education, led by a full-time team of five people and delivered by 500’s global experts, programs are delivered on Silicon Valley, in Egypt, Saudi Arabia,? Japan, Canada and online. Education serves multiple purposes to build the 500 brand, develop dealflow, educate more future co-investors and drive revenue to the firm.

7.?????????? Convertible Structures

We believe there are multiple, different convertible structures being used to fund emerging fund managers. We have heard some great stories on how they have been structured and used successfully in both PE and VC firms.

7.1 Convertible loan into the GP, will roll into an LP position at final close

One significant PE fund described how they had pooled a large number of business angels, invited them to invest into a GP convertible loan, and then planning to roll it into the fund as an LP position at final close. This would allow the GP to access the capital early, for working capital purpose, then effectively pay it back at closing, via final close capital from other LPs, and then roll that capital into the fund, on behalf of the angel syndicate.

8.?????????? Creative Fund Economics

Just like the name implies, creative fund economics may not always be popular with all LPs (notably, institutional LPs), but, within the boundaries of a qualified LPA (Limited Partners Agreement), there are numerous (more or less) creative ways a GP can fund things beyond the standard 2/20 & capital call schedule.

8.1 Sign on fee

In rare cases, we have seen an initial, one-time sign on fee, for LPs into the fund. The fee can range from 0,2% up to 2% of committed capital for the LP. This is typically applied to smaller LPs, under a certain commitment amount.

8.2 Front-Load Management Fees

While most funds follow a 2&20 model, more than 50% of all funds change the 2% structure during the lifetime of the fund. UK-based SuperSeed Venture Fund has a “2-2.5% per annum for 5 years. 3 years paid up front on subscription. 2 years paid by Investor on exit” -model. Other funds have up to 3% for the first 5 years, then declining to 1% afterwards. Overall, most LPs seem quite accepting of higher-at-first-then-declining-afterwards-management fees.

8.3 Management Fees (Standard)

Industry standard, 2% management fee is well-known. But 2% of what? Different funds apply this differently. 2% of committed capital? 2% of called capital, 2% of invested capital or 2% of NAV? The decision here will lead to vastly different actual fees on the fund. According to finance Professor Filippo Ippolito, the average lifetime fees on a VC fund comes out at 21,38% Clearly, some room for flexibility here for GPs, just stay within the boundaries of the LPA. Also worth noticing, according to Carta, between 30% - 40% of all funds are able to claim above the 2% management fee, with up to 5% able to secure over 3% management fee.

8.4 One Time, Startup Cost

Some funds apply a one-time, initial startup cost to the fund, to cover the initial setup. This would typically cover legal costs, regulatory cost and similar. This one-time startup costs would be charged to the fund.

8.5 Fund Cost

Our friends at VC Lab offer a good overview of what counts as fund cost (expensed to the fund) and what counts as management fee. Interestingly, most emerging fund managers seem to not have a clear understanding of how the economics here, missing out on vital details how costs are split between the manager and the fund. While it may be possible, according to the fund’s LPA, to assign expenses to the fund, forward-thinking GPs will work hard to keep these costs to a bare minimum, possibly even cover them out of the management fee. Any cost taken by the fund, will reduce available investment capital, and raising the return barrier to return the target multiple back to the LPs

8.6 GP Commit, Recycled

Connecting back to point 1.2 above, the GP can pay in the GP commit, and use this capital quite flexibly until the fund is fully deployed. This paid in GP commit acts as the most flexible capital in the fund’s capital stack, and can be recycled for various purposes, until the final close of the fund, at which time the full GP commitment must be met. Again, we would always refer back to the LPA.

8.7 Deferred payments?

It has been suggested that deferring payments with service providers, like law firms, accounting firms and fund administrator funds might be yet another way of shaping your GP business model. While we recommend all GPs to negotiate the best possible payment terms, we are uncertain whether this counts as a business model. Happy to hear your thoughts in the comments below.

9.?Deal Fees

Deal fees came up repeatedly in our interviews. While detested by (most) founders, it is a legit method for (most) funds to fairly share costs with the companies they end up investing in. In certain cases, GPs can also charge deal fees to fellow co-investors, further offsetting their own costs on the deal. Mountside Ventures founder Jonathan Hollis discusses deal fees in his “Unpopular opinion - deal fees should not be contentious” article.

9.1 Legal, DD, ESG, Impact deal cost recovered

While not large amounts, some firms will specify in the term sheet, that the company receiving the capital would also bear the cost of the due diligence and legal review. More recently, we have also started seeing funds charging the costs of the ESG and impact assessment. The standard is to cover direct costs, incurred by external providers, like a law firm, accounting firm or impact assessment firm. Saastr Founder Jason Lemkin believes this should be industry standard.

9.2 Deal Fees from Startup / SME

Building on the previous item, we have seen a limited number of funds charging a deal fee to the company receiving the investment. This could be a 0,5% - 2% fee for the work incurred by the deal team, especially in circumstances of extensive due diligence. In these cases, the fee structure should always be clarified in advance, in the initial term sheet, as described by the team at Zive. 9.3 Deal Fees from Co-investors “Fees are all over the map”, says Andrew Bernstein, Head of Private Equity at Capital Dynamics, referring to how GPs work with co-investors on deals they lead. Bernsteins views are similar to what we found, where fees to co-investors range from zero, to upfront fees, deal intro fees, DD fees, success fees and more. “Fees chargeable is very much opportunity dependent”, says Neda Vakilian, Partner at Actis. Ultimately, the fees charged co-investors on a deal comes down to one thing; strength of bargaining position.

10. Deal Advisory

The border line between deal fees and deal advisory can be slim. But a successful GP can combine investment work with deal advisory, increasingly becoming a trusted partner to existing LPs or co-investors. This is especially relevant in emerging markets, like Africa, where international investors may want to consider partnering and relying on local expertise to assess and advice on the deal.

10.1 Advisory on Deals From LPs/Co-Investors

Entrepreneurial-minded GPs might want to consider setting up a deal advisory service for both LPs, future LPs and co-investors, effectively operating as an investment advisor in the same sector as the GP also invests in. While this may be complicating or even distracting for the GP; it could also greatly strengthen the position and relationship between the GP and the clients, while also bringing in some sorely needed fees.

11.??????? Operating Roles

An investment firm will take from 0,1% to 100% equity in the company it invests it, leading to wildly different relationships and expectations on operating roles. But most GPs can bring valuable, operating expertise to the table for the portfolio companies. Stepping into a portfolio company operating role, as part-time CFO, flexible CTO or even fractional CEO should not be discounted by GPs for limited time periods. We find both operating roles and board seats having the possibility to fund the GP team, and should be considered by emerging managers.

11.1 GP Members Take Part-Time, Full-Time Operating Roles with Portfolio Companies

While not common in VC, we see multiple examples of GPs taking paid full-time or part-time management and operations roles with the portfolio companies . The concept of fractional CXO has been on the rise lately, and VC/PE firms can apply both fractional or interim management during various stages of the company’s lifespan. While normally understood to be outside executive, is it fully accepted that the operating role can be filled from the investment firm. In fact, this is the role of many GP operating partners in both PE and increasingly also in VC.

11.2 Paid Board Seats

While many LPAs regulate that GPs will not charge board fees from portfolio companies, a GP can structure this in a way that enables the firm’s representatives to charge market-standard board fees for portfolio companies. Assuming a partner holds 3-6 board seats, this might sum up to cover a significant part of her salary with the firm. The partner’s salary from the firm would then be adjusted in line with the board seats.

12.?Consulting

By far the most common way of funding the GP that we found was the consulting practice or consulting work happening on the outside of the fund’s legal structure. From investment advice to strategy advisory, maybe as many as 50% of the emerging managers we’ve spoken with refer to some kind of consulting practice on the side, helping fund the transition period into full-time investing (and a sustainable GP business model).

12. Outside Consulting Work, Disconnected From the Fund

While having the possibility of bringing in good money, most see the outside consulting work as a major distraction from the focus on the fund. Equally, many LPs will frown if key personas are spending a significant amount of time running a consulting practice on the side. Realistically, many emerging managers have this as the ‘shortest route to stable income’ while building their first fund, but we believe there are multiple better revenue options to pursue, to better focus on the fund.

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Want more? Go for merch!

While we believe these 12 categories cover 98% of all working capital options, we want to acknowledge the impressive rise of Hustle Fund merch available. From “be nice, make billions” mugs ($16M), toddler-sized “Eat, Sleep, Hustle” ($21) and the XXXL Hustle Fund Hoodie ($40), Hustle Fund’s online merch store counts more than 200+ items, with the potential to drive some serious revenue for the fund. Want to get inspired? Check out the store.

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Find your GP (working capital) business model

Working capital is a genuine challenge for emerging fund managers around the world. Much focus has been on providing new working capital facilities. While more capital surely would be beneficial, maybe a good starting point is to explore these 12 categories and design your unique GP business model? One thing is certain, for most emerging fund managers, it is likely to be a creative patchwork of different ways, put together to make your own, unique VC/PE business model.

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Want to learn more?

Explore our upcoming VC Masterclasses in places like Luxembourg, Dubai, South Africa, London and online. Get in touch at [email protected]

Big thanks to Scott Newton , Rick Rasmussen , Marc Penkala , Sandrine Henton , Maelis Carraro , Peter Tropper , Mark Kleyner , Marijn Wiersma , Jessica Espinoza , Elena Haba & the entire team at 2X Global & 2X Ignite for valuable input into the early ideas for this work. Here's to building better VC & PE funds.