PE, VC funds slash their fees, aim for higher carry

The emergence of multi-fund platforms led several PE and VC firms to move away from the traditional ‘2-20 model’, or 2% management fee and 20% carry, where the fund retains a part of the investment profit upon realization.

To be sure, this new trend is seen in firms raising multiple funds with large corpus and smaller ones that are into their subsequent fund cycles. Small franchises with a single-fund structure still charge a 2% fee to meet management costs.

In some cases, the funds are either charging zero fees or have reduced it significantly to 1%. Some firms that have done this include Sixth Sense Ventures, 3one4 Capital, Kae Capital (in their opportunities fund), Artha Venture Funds, Elev8 Venture Partners, and TVS Capital.

“The issue is with the 2% management fee. LPs (limited partners) are bargaining for a lower fee to ensure better IRR (internal rate of return) outcomes," said Gopal Srinivasan, the chairman and managing director of TVS Capital.

IRR is the internal rate for a PE or VC fund, or the annualized return a fund will generate based on a series of cash flows over the fund’s tenure, typically 10 years.

For example, when a general partner (GP) raises ₹100 from an investor, there is a 2% upfront fee that the firm charges each year. By the time the fund, with a lifespan of 10 years, is into its fourth year, already ₹10 is earned as fees, bringing down the investible corpus to ₹90. “The LPs are pushing back on this. They are fine with a higher carry, but management fee is being squeezed," a GP who has recently raised a new fund said on condition of anonymity.

For Artha Venture Fund I, the company had set the management fee of 1.5%, emphasizing higher carry beyond a 24% IRR. In its winners’ fund (a fund raised separately to invest in best-performing assets of fund I), Artha Select Fund charged a 0.75% management fee and incorporated a 10% no-catchup hurdle, anchoring the strategy in performance-driven returns.

In some cases, where the firm is confident of its investment thesis, they go for a higher carry or percentage of the total money it can generate after the entire corpus is invested and harvested. New fund structures ask as high as 30% of the carry in some cases, and in some, it is 25%.

“As we strategize for Artha Venture Fund II, our forthcoming seed venture, we’re contemplating a management fee between 1% and 1.25%. We’ll maintain our commitment to the no-catch-up hurdle, ensuring the protection of our investors’ initial IRR and challenging our team to achieve returns that amplify our investors’ faith," said Anirudh Damani, the managing partner of Artha Venture Fund.

Catch-up takes effect when an investor’s returns reach the defined hurdle rate, giving them an agreed level of preferred return. The manager then enters a catch-up period, in which it may receive an agreed percentage of the profits until the profit split determined by the carried interest agreement is reached.

According to Damani, these tactical recalibrations preserve the sanctity of VC investing in India and set the country apart from the US paradigm. In India, fund sizes are approaching US standards, yet operational costs remain distinctively different. The conventional 2/20 model feels outdated and misaligned here. Through these innovations, the aim is to balance risk and reward, offering a robust and reimagined investment model.

“In 2015, we had a unique opportunity to reexamine the VC fund structure and establish a stronger foundation for LP alignment through innovative commercials. Through our decisions and since then, we have managed to demonstrate that such a structure can lead to superior performance for the investors," said Pranav Pai, the co-founder of 3one4 Capital, which recently raised $200 million towards its fourth fund. According to Pai, the firm does not follow the 2-20 model. Though a person with knowledge of the firm’s plans said they charge higher carry, Pai declined to share specific details.

For firms that are managing billions of dollars, the cost overheads of managing funds come down. And for LPs returning to invest in subsequent funds, it makes more financial prudence to have lower fees, experts said.

Life is all about change, said Sasha Mirchandani, founder and managing director of Kae Capital. The firm offered lower fees, around 1.5%, 1.25% and 1%, to investors of its opportunities fund based on how much they invested in the new fund. According to Mirchandani, the industry is changing. “In some cases, like ours, we are proactively charging less and, in some cases, there is a pushback from LPs. There will be many more funds that are likely to charge less," he said.