A venture capital fund is typically structured as a Limited Partnership (LP). This legal setup creates two distinct classes of partners: the General Partners (GPs) and the Limited Partners (LPs). Think of the GPs as the pilots of the ship. They are the venture capitalists who find promising startups, conduct due diligence, make investment decisions, and actively manage the fund's portfolio. They have unlimited liability for the fund's debts, which is a key reason they manage it so carefully.

The LPs are the passengers who provide the fuel. They are typically institutional investors like pension funds, university endowments, or family offices that commit capital to the fund. Their role is passive, and their liability is limited to the amount of money they've agreed to invest. They trust the GPs to generate strong returns on their behalf.

Most venture funds have a defined lifespan, typically 10 years, though this can often be extended by a few years. This decade is split into two main phases.

1. Investment Period: For the first 3-5 years, the GPs are actively sourcing new deals and deploying the LPs' capital into startups. This is the

When an LP agrees to invest in a fund, they don't wire the entire amount on day one. Instead, they make a capital commitment. The GP then makes a "capital call" when they need funds to make an investment or pay management fees. This allows the LP's capital to remain productive in their own accounts until it's actually needed.

This process is governed by the commitment period, which usually aligns with the fund's 3-5 year investment period. During this time, the GP can call on the LP's committed capital to make new investments.

To run the fund—paying salaries, rent, and other operational costs—GPs charge a management fee. This is the "2" in the classic "2 and 20" model. This annual fee is typically 2% of the total committed capital during the investment period. For a $100 million fund, that’s $2 million per year.

After the investment period ends, the management fee often "steps down." The fee might decrease to 1.75%, 1.5%, or be calculated based on the net invested capital (the cost of investments still held) rather than the total committed capital. This reflects the shift in focus from finding new companies to managing and exiting existing ones.

The "20" in "2 and 20" refers to carried interest (or "carry"), which is the GP's share of the fund's profits. It's the primary incentive for the GP to generate strong returns. However, GPs don't just get 20% of all profits automatically. The distribution of proceeds is governed by a structure called the waterfall.

First, LPs must get their initial investment back. This is known as the return of capital. After that, there's often a hurdle rate—a minimum rate of return, typically 8% annually, that LPs must receive before the GP can start taking their carried interest. This ensures the fund performs at a baseline level before the managers are rewarded.

Once the hurdle rate is met, a GP catch-up clause often kicks in. This allows the GP to receive a larger portion of the profits (sometimes 50% or even 100%) until they have "caught up" to their 20% share of the total profits distributed so far. After the catch-up, profits are split according to the final 80/20 arrangement.

There are two main types of waterfalls:

The American waterfall is more common in US venture funds, as it rewards GPs sooner for successful early exits. However, it introduces the risk of a clawback provision. If early deals are big wins but later deals are losers, the GP might end up receiving more than their 20% share of the final, total fund profit. The clawback provision forces the GP to return the excess carry to the LPs at the end of the fund's life.

Understanding these mechanics—from the partnership structure to the flow of fees and profits—is crucial for evaluating how a venture fund operates and how the incentives between investors and managers are aligned.