January 26, 2022

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Meaning of Management Fee in VC and Key Explanations

The management fee means a charge on the total fund provided by limited partners in venture capital financing to meet administrative expenses such as payment of salary, lighting and cooling, and its advisory role.
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The management fee is usually charged by venture capital firms for their job of investing in private equity companies, popularly known as startup businesses. This fee is paid by the limited partners or investors and not the investee company. In this article, I will define Management fees and give a detailed explanation of them.

Definition of Management Fee

The management fee means a charge on the total fund provided by limited partners in venture capital financing to meet administrative expenses such as payment of salary, lighting and cooling, and its advisory role.

Key Explanations

The management fee is charged on the committed capital of the fund. The maximum fee that is charged is 2 percent. Moreover, a Venture capitalist may charge a lower or higher fee. The fee is usually charged over the lifetime of the fund. And most venture capital funds are for 10 years. In other cases, flexible fees may be charged. Maybe 2 percent might be charged for the first three years. And 1.3 percent for another 4 years and so on.

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The management fee is charged by VCs to meet daily operations. Why? The VC partners will pay the salary of employees, rent and maintenance of the building, fueling and cooling, and other operating expenses required to achieve the goal of the firm. It is from the management fee that these expenses are paid.

The management fee is included in the total fund that will be invested by the limited partners. Therefore, when you sum up the annual management fee, this will give you the lifetime fee of the fund. Also, the investment capital is the committed capital less the lifetime fee. This is as explained by a venture capital textbook.

Next, understanding the lifetime fee and investment capital can help in calculating the return on investment (ROI) that must be earned from the investment/fund for the venture capital firm to break even. This is calculated with the formula lifetime fee divided by investment capital. The VC must earn above the breakeven ROI to make a profit to the investors. If the ROI is 20 percent, it means that the investor must earn 20.1 percent and above to earn profit for the fund. If it earns below 20%, the VC has incurred losses.

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Conclusion

It is an income to the venture capitalist. It is from the fees every operational expense is paid. This is usually between 0.1 to 2 percent. In some cases, the VC may use variable fees on the committed capital. The sum of the annual management fee is the lifetime fee. Knowing the lifetime fee and the investment capital can help you know the breakeven point to earn a return on investment.

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