This guest post is authored by Mark Bivens. Mark is a Silicon Valley native and former entrepreneur, having started three companies before “turning to the dark side of VC.”

He is a venture capitalist that travels between Paris and Tokyo (aka the RudeVC). He is the Managing Partner of Shizen Capital (formerly known as Tachi.ai Ventures) in Japan. You can read more on his blog at http://rude.vc or follow him @markbivens. The Japanese translation of this article is available here.

There’s an old dig that venture capitalists like to make about private equity professionals: private equity folks boast about the size of their ego in AUM, whereas VCs know that what really matters is their IRR.

Now let’s define these three-letter words. First, I’m using the word ego as a euphemism here to be gender agnostic (albeit in reality it’s usually only men who tend to make this brag). AUM means assets under management (i.e. the total amount of money in the funds managed by the general partner team). IRR means internal rate of return (i.e. the cash returns distributed to a fund’s investors, annualized).

Asset managers care about AUM because it directly translates into guaranteed revenue. Closed-end investment funds typically follow a “2 and 20 model,” meaning annual management fees of 2% and a share of 20% of the capital gains generated by the fund (aka carried interest). The annual management fees are a direct function of AUM, i.e. 2% of total AUM each year. They are contractually established for the life of the fund, usually 10 years. The carried interest is a direct function of fund performance, i.e. 20% of the capital gains generated by the fund.

Accordingly, a large AUM directly translates into a significant guaranteed revenue stream for the entire life of the fund. A fund manager with $1 billion in AUM is probably receiving around $20 million per year in recurring revenue. A micro VC fund of say $10 million is receiving only $200k per year in recurring revenue via its management fees. 

Risk of misalignment

Since management fees are meant to cover the operations of the fund, excessively high management fees can translate into high salaries for the managing partners, luxurious offices, and lavish parties. Even if the fund’s financial performance is lackluster, a guaranteed annual revenue stream in the double-digit millions for several years makes for a fairly comfortable lifestyle. Do you see where a potential misalignment can emerge?

In contrast, a small VC fund can afford no such excesses. The managers of a small VC fund cannot become wealthy on management fees alone. They must perform. Only by generating significant capital gains on the funds they manage will they be able to generate wealth for themselves via the carried interest mechanism. IRR represents each fund’s financial performance.

For LP investors in private equity or VC funds who care about financial return, IRR is the metric that reflects their financial return, not AUM. So I submit that when a fund manager brags about their AUM, the appropriate rebuttal would be to ask their IRR.

Full disclosure: I too used to be guilty of the AUM flex. As a former GP in a fund that managed nearly $1 billion in AUM, I would often open my introduction at conferences by citing this figure. But over time, I learned that IRR represents my true KPI as a fund manager. IRR is the indicator of how well or how poorly I perform my job. It is not a mathematical anomaly that my best-performing funds have been those with smaller fund sizes, hence lower AUM.

In many ways actually, a propensity to chatter more about AUM than IRR is an indication of the stage of an ecosystem. When the venture market in a given region is still nascent, track records are limited, so the nearest metric people can look for is assets under management. However, once a fund manager has progressed beyond their first vintage, the more the relevant question to ask is, “So what is your IRR?”

This guest post is authored by Mark Bivens. Mark is a Silicon Valley native and former entrepreneur, having started three companies before “turning to the dark side of VC.”

He is a venture capitalist that travels between Paris and Tokyo (aka the RudeVC). He is the Managing Partner of Shizen Capital (formerly known as Tachi.ai Ventures) in Japan. You can read more on his blog at http://rude.vc or follow him @markbivens. The Japanese translation of this article is available here.

During a return visit to France last month, I caught up with a successful French entrepreneur (whom I wish I would have backed on his first venture, but that’s another story). Anyway, he opened the conversation with flattery, claiming that I had inspired him. So of course I’m growing suspicious at this point, either expecting a punch line or reconsidering my assessment of his sound judgment. But he wasn’t joking. Rather, he stated that a blog post I wrote several years ago inspired him to adopt a habit which has now given his company a competitive advantage in recruiting talent.

Specifically, he was referring to something that I had written way back in 2013: The importance of blogging for entrepreneurs.

As I posited back then, regular blogging is about far more than shameless self-promotion; it’s about communication of thoughts, transparency in opinions, and beta-testing ideas with the sounding board of your readers. Regular blogging exercises the muscles of intuition and creativity. It facilitates achieving clarity in your mind’s eye, and it establishes you as a thought leader in your domain.

The fifth benefit I had cited in particular has proven especially relevant to this French entrepreneur I caught up with. Consistent blogging over the years is paying dividends to him now as his most effective recruiting tool.

The market for hiring talent, especially software developers, is insanely competitive right now across Europe, he told me. Startups are finding themselves outbid for developers by deep-pocketed incumbent companies, or increasingly, by other startups who have recently closed on massive fundraising rounds.

By having established his voice over the years through blogging, this guy inadvertently compiled a loyal following of readers who subscribe to the narrative of his ambition. Now, when he posts a job opening, he benefits from a ready-made audience. Better yet, candidates from this audience often prove to fit well culturally, because they’ve already been indoctrinated into his company’s vision over the years.

Blogging is playing a long game. The fruits of it do not appear immediately, causing many people to abandon it prematurely. Yet this entrepreneur is now reaping the rewards of his long-term investment. Given today’s war for talent, by accelerating the recruiting process and attracting individuals who are already on board with his project, the returns are astronomical.

Granted, the world has changed in the 8 years since I originally wrote that piece on the powers of blogging. There are other ways to evangelize and build a following as an entrepreneur. Podcasting, for example.

Creating something that does not rely on the approval of others can offer limitless upside. Naval Ravikant refers to this concept as permissionless leverage.

Code and media are permissionless leverage. They're the leverage behind the newly rich. You can create software and media that works for you while you sleep.

— Naval (@naval) May 31, 2018

I like this articulation and will adopt it too.