How does a venture capital fund work?

A venture capital fund is a pooled investment vehicle structured as a limited partnership. A management company — run by the general partners (GPs) — raises money from outside investors called limited partners (LPs). LPs are typically university endowments, pension funds, family offices, sovereign wealth funds, and high-net-worth individuals. The fund documents (the limited partnership agreement, or LPA) spell out the terms: how long the fund lasts, how fees and profits are split, and what kinds of companies the GPs can invest in.

Once the fund is closed and capital is committed, the GPs start deploying it. Most VC funds have an investment period of three to five years, during which they make new investments. After that, the fund enters a harvest phase where the focus shifts to managing existing portfolio companies and waiting for exits — typically via acquisition or IPO.

The fund's lifespan is typically ten years, sometimes extended to twelve or thirteen. During those ten years, the GPs try to build a portfolio of startups that collectively returns more money than the LPs put in — ideally much more. Because most startups fail, VC is a power law business: a small number of home runs (think Uber, Airbnb, Stripe) have to return enough to cover all the losers and still make a profit.

GPs are compensated in two ways: a management fee (typically 2% of committed capital per year) to cover operating costs, and carried interest (typically 20% of profits) paid only after LPs get their capital back. This structure aligns GP incentives with LP interests — both parties only win big if the portfolio performs.