Fund Distributions

Fund distributions are the capital payouts granted to your venture fund’s partnership from liquidity events throughout the fund lifecycle. There are four inflection points at which distributions can be carried out:  

1. When the startup pays dividends to the venture capital (VC) fund.  
2. When the fund has a liquidity event through a merger and acquisition (M&A) transaction.  
3. When the fund sells its equity stake in the secondary market. 
4. When the startup issues an initial public offering (IPO), and the fund sells those shares.  

In general terms, limited partners (LPs) typically consider their investment in a venture fund successful if it returns at least three times their committed capital and more than 25% IRR after 10 years.

Why do distributions matter to LPs? 

The size of distributions matters to LPs for obvious reasons, but the effective management of distributions matters, too. Distribution policies and processes reflect an investor’s partnership style and business acumen. Cash flow management is relatively straightforward in the first years of a new venture fund because the primary operations involve drawing down capital and investing it into new opportunities. As the fund progresses and you start to see large financial outcomes, cash flow management becomes both increasingly important and more complex.

When planning for distributions, here are a few things to keep in mind: 
 

Liquidity takes a long time

Venture capital (VC) typically takes longer to produce distributions than all other forms of private equity (PE), as confirmed by 2020 Pitchbook data. In fact, distributions in venture capital funds “tend to be the most frequent and robust during Years 11 and 12 for VC funds, and only half of these vehicles fully liquidate by Year 14.” Although this timeline has been shrinking in recent years, it is still important to be aware of it.  
 

You set harvesting schedules

While your limited partnership agreement (LPA) dictates your distribution strategy and waterfall at a high level, you still have a lot of flexibility in determining when and how you pay out distributions to your LP base. Jim Marshall, head of SVB’s Emerging Manager Practice, advises general partners (GPs) to be deeply thoughtful and transparent about their distribution strategy at the fund’s outset. “You should have a set rule about when you distribute versus when you hold, and that when you distribute, you will do so within 90 days of an event,” he says.  

“Consider adding the flexibility of recallable distributions in your LPA,” recommends SVB Capital CFO Zankhna Vasha. “If there is uncertainty around the fund’s future cash needs, recallable distributions allow you to improve your IRR by distributing immediately and preserve the ability to call it back within a determined period (say, 12 months), if needed.”  
 

Consider your reinvestment and recycling strategy

While your fund’s absolute performance will be the biggest determinant in distribution rates, you can affect outcomes by considering how and when you plan to recycle capital versus pay investors out. For example, funds that offer dividend payouts provide more consistent distributions earlier and more frequently but are less likely to provide outsized distributions. Smaller and more concentrated funds that re-invest capital are more likely to deliver larger distributions later in the cycle due to large liquidity events. “Most LPAs permit up to 110-115% of committed capital to be deployed, which can be advantageous for you as the GP, depending on your strategy,” says Daniel Dehrey, a managing director on SVB’s Emerging Manager Practice.

Learn more about fund recycling in this blog post from IA Ventures’ Roger Ehrenberg. 

A growing secondary market creates opportunity and complexity

In recent years, the secondary market has grown tremendously. New liquidity paths like special purpose acquisition companies (SPACs) have become available, creating new avenues for value creation for both GPs and LPs. However, such vehicles also introduce significant complexity when it comes to modeling returns and distributions. Lean on your back-office team and fund management experts to ensure your models are accurate.

Show true value using multiple metrics

As your fund progresses, both the pace of your timelines and the cash value of your outcomes will affect your metrics. As your metrics change, it’s important to track your performance in multiple ways. For example, while a fund may post superior distributions to paid-in capital (DPI) or total value to paid-in capital (TVPI) compared to some of its peers, LPs will also want to consider how long it took that fund to return capital. Juxtaposing multiple metrics can produce a more complete picture of a fund’s performance.

Most LPAs permit up to 110-115% of committed capital to be deployed, which can be advantageous for you as the GP. Daniel Dehrey Managing Director, SVB Emerging Manager Practice

Consider in-kind distributions

“LPs have recently shown interest in receiving in-kind distributions of securities for companies with a potential for future appreciation,” says Vasha. “The in-kind distributions also allow taxable investors to do some tax planning by timing the sale and realization of these securities.” Some factors worth considering for in-kind distributions include: 

• Incremental market risk 
• Additional administrative burden 
• Composition of investors in the fund regarding tax status, sophistication to handle sale decisions (institutional versus non-institutional), etc.  

Think twice before holding public stock

Public stock represents a different type of risk compared to a commitment to back an emerging manager’s fund. “In my opinion, VC investors shouldn’t hold public stock,” says Marshall. If your fund strategy necessitates something different from the venture capital norm, communicate this need to your LPs early and transparently.  

What does a distribution notice include? 

LPs expect your distribution notice to include three elements: 

1. A cover letter that details:
   • The net distribution amount due to investors 
   • The type of distribution (cash or stock) 
   •  A description of the distribution type (e.g., sale, dividend recap, income, etc.) 
2. Additional details, including:  
   • The fund investment’s amount distributed to date and:
     • the cost basis of the remaining investment (if partially exited), or
     • the total multiple of invested capital (MOIC) and IRR (if fully exited) 
   • The amount of carry accrued and/or paid to the GP and any amount held in escrow 
3. An Excel spreadsheet including all financial details of the transactions 

 

Resources

Review these Capital Call and Distribution templates

• Capital Call & Distribution Notice Sample Cover Letter and Description by Institutional Limited Partners Association (ILPA)

• Capital Call & Distribution Notice Excel Template by ILPA

• VC Portfolio Construction Model and Cash Flows Template by Dan Clayton, SVB Capital​