At $377,000 a year are venture capitalists overpaid? Yes and no – here’s why

Editor’s note: Startup Spotlight is a regular part of WRAL TechWire’s Startup Monday lineup which features our exclusive Startup Guide, a breakdown of upcoming events across North Carolina, a guide to tech and other meetups across the Triangle, and Startup Rewind (a recap of last week’s headlines.) Investor and entrepreneur David Gardner is founder of Cofounders Capital in Cary and is a regular contributor to WRAL TechWire.

CARY – There was an interesting article last week in Pitchbook reporting that Venture Capitalists continued to take healthy bonuses even during the 2020 pandemic. According to Pitchbook, even VC associates received bonuses on average of $40K-$60K. This got me thinking about the industry pay scale for VC partners which salary.com reports an industry median of $377,775 in 2020.

So….are VC’s overpaid?

YES

A top tier VC can easily make over $20M a year. This includes both salary (paid out of a fund’s allowed expense ratio) and “carry” which is typically the 20% of the fund’s profit which venture fund management teams enjoy if they are successful.

David Gardner

When you consider that VC’s aren’t required to invest any of their own capital into the funds they manage and that they get on average rather lucrative salaries (even if their fund loses money) then yes, it’s fair to say that many VC’s are overpaid.

And NO

On the other hand and as is usually the case when answering business related questions, “it depends”. Fund managers are typically allowed a 2% annual management fee to cover all fund expenses and salaries.

That 2% has to cover all salaries, rent, travel, insurance and often tax prep and legal fees which can exceed $100K just to set up a new investment fund’s documents. If a VC is managing a $500M fund then that 2% equals a $10M per year budget which can pay for some very nice salaries and office digs.

Now consider a first early stage venture fund which is typically under $5M. 2% of that size fund is only $100K. Typically, there are at least two VC’s managing even that size fund who have to figure out how to cover all of their expenses and squeeze out a livable wage from that budget for the next several years while hoping their fund returns a profit.

As you start to understand how VC’s are compensated, it becomes easier to understand how large, later-stage funds just keep getting bigger every year while there is an ever diminishing part of the pie going into smaller early stage funds. In general, VC’s want to be in the largest fund possible because that is where they can personally make crazy amounts of money.

Business problems often have compensation at their core. Venture capital is no exception. The biggest single threat to innovation and entrepreneurship that I see today is this perpetual shift of investment dollars from smaller early stage funds to much larger later stage funds. Large late stage funds have to write very large size checks so they need to invest in large companies that can absorb and use that much capital. Startups and early stage companies can’t deploy that much capital so they need small funds to write smaller checks.

It can be perplexing to try to figure out why larger funds continue to grow ever larger while the amount of capital going into smaller funds (which historically have generated better returns) continues to diminish each year. Understanding how VC’s are compensated provides insights into this dynamic as well as into innovation in general. Most innovation comes from entrepreneurs in early stage companies. When fund managers gravitate away from raising smaller funds because of compensation, early stage companies suffer the most. When no one wants to do the heavy lifting of raising and deploying early stage capital from a small fund…that’s when innovation in our country will slow to a snail’s pace.