Why do you even need the 10-year venture fund?

Before I'm called out as a hypocrite or traitor to my fellow venture capitalists, please read on - it's for your own good.

As venture capitalists or private equity professionals, we talk to entrepreneurs and founders about thinking outside the box, being innovative, pushing the envelope. Yet this cottage industry called venture capital really hasn't developed that much over the years. (AngelList tried...)

I'm been having a debate with a couple of friends, as to why do we need a ten-year fund? Why not a five-year fund? Why can't we accelerate everything and generate returns for our investors earlier? Hear me out...

We're questioning the conventional wisdom of venture capitalists, as to why should a fund be "10" years when startups are scaling faster thanks to technology and information?

Time to "Unicorn" is 6 years on average. Within Asia, it's 5 years... or so the following data says. (I had to pick this chart as I had a hunch, but thanks to Fleximise for putting this together.)

Here's the dirty little secret: Fund Managers aka GPs aka General Partners charge a management fee. In our lingo, we call this 2/20 formula → 2% management fee & 20% carry (aka profit share).

Now, there's an incentive right there in that formula. As long as the fund is active, the fund manager can charge 2% for "managing" the fund.

Don't get me wrong, it's no easy feat, there's a lot of effort involved (and the irony is that these same fund managers don't want to pay placement agents any retainers for helping them raise that fund, that's another story for another day).

So you see, there is a minimum size to a fund to make this work. If you have a $100 million fund, that's a nice $2 million going towards salaries and administrative expenses each year. (If you manage a $25 million fund, that's only $500,000 each year.) But if you do this for 10 years, that's about $20 million over 10 years.

Think about this, 2% for 10 years, that's about 20% over the investment horizon. I know I'm simplifying... keep reading.

The funny thing is when you do the math and look at the performance of venture funds over the years, you'll realize that most of the money is made by the GP aka fund manager, with very little returns given back to the Investors aka Limited Partners aka LP.

Now you know why the "Power Law" is important for them/us and why "10 Bagger" means the LP is left to hold the bag. 20% IRRs or 2% IRRs? Oh, we're okay speaking about multiples instead and ignoring the time value of money.

And yet, in all this, we never even questioned why NOT do a 5-year fund?

• Is it because we can't continue to collect a steady management fee and pay those nice large salaries to the partners and associates?
• Or is it really that it takes time for startups to scale up? (see above diagram incase you missed this point)
• Or is it because there are not enough players in the venture funding cycle, all the way from Seed & Series A, through to B, C, D & private equity players.
• Or is it because we don't see an IPO happening for the next few years, thanks to "market conditions" and we need to keep our "jobs". (btw to my Indian VC brothers... I feel you when you say there has not been any real tech IPO)

When sharing this thought with one of my VC investor friends, he rebutted that the number of startups were larger than before, and that it took more time to filter through them.

Granted. I merely suggested that as a technology investor, he use Zoom - so instead of doing three physical meetings a day, he could pull off five or six if required.

He drew a blank stare.

What do you think?

• If you're a venture capitalist and you're too scared to talk about it? (I understand - it's impression management.)
• If you're an investor, have you ever asked this question, and what do you think we're doing with your money?

Update: I thought I'd include this thought shared by a friend who didn't want to comment...

Roger Bannister beat the 4-minute mile limit. The rest is history, now others do it.

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Jose Paul Martin is a private equity investor & advisor with over 15 years of experience in strategic & financial advisory and currently focuses on the FinTech & HealthTech space. Connect with him... or feel free to join his newsletter if you enjoy his articles.