Teaching notes:

VC compensation exercise
Dr. Robert Cressy
 Class exercise 2:
VC compensation
 Suppose Lydia VC has raised a $1 billion
fund for early stage investment
 She will
 invest this money (for simplicity, immediately)
in fast growth businesses
 Then manage the businesses to IPO over the
next 10 years
 She has 4 other partners also who act as
investment managers

2
 They are paid salaries from the VC’s
annual Management Fee
 We ignore all other expenses for simplicity
 Suppose that after 7 years she sells (again
for simplicity, in one go) her investments
for $7billion via a set of IPOs
 However, payments to underwriters at IPO
eat up $1bn of this gain
 Assume that
 all payments to the partnership are divided equally
amongst the 5 partners
 even though the investments are cashed in after 7
years the partnership continues for the full 10 years.
 ‘Carry’ or Carried interest is paid at 20% of the capital
gain
 Management fee is 2% of the initial value of the fund
 Question:
 What is the average partner compensation (total
payments per partner over the 10 year fund)?
 Answer
 Total payments to all partners over the 10 year
period are (in $bn):

P  (7  2)(.2) ("Carry")
 10(1)(.02) (" Management fee")
 1.2

 Average payment per partner over the 10 years

is therefore
P / 5  0.24bn  240m
5
 This gives a partner ‘only’ $24m per
annum on average over the 10 year
period!