When it comes to investing in venture capital funds, there are two important terms that you need to be aware of: commitments (not the Film about the Irish soul band) and drawdowns. I came across a chief of staff at a family office recently who didn’t understand them, so let’s try and keep this nice and simple. In a nutshell, commitments refer to the amount of money that an investor has pledged to a particular fund, while drawdowns refer to the actual amount of money that is drawn from that commitment. In this blog post, we’ll take a closer look at these two concepts and how they work together in venture capital fund investments.
Venture capital funds are typically structured as limited partnerships, with a general partner (GP) managing the day-to-day operations of the fund and limited partners (LPs) providing the capital. LPs typically commit a set amount of money to the fund over a period of time, typically three to five years.
Once the fund has been established and has raised a certain amount of committed capital from LPs, the GP can begin deploying that capital into investments. GPs will typically make periodic “draws” from the committed capital pool as they invest it into portfolio companies.
In most cases, drawdowns are taken in tranches or instalments. For example, an investor who has committed $5 million to a venture capital fund may have their money drawn down in four instalments of $1.25 million each over the course of four years. This gives the fund manager some flexibility in how they deploy the capital and also provides some downside protection for the investor in case the investment doesn’t pan out.
As these portfolio companies generate exits—through an IPO or being acquired by another company—the GP will return capital to the LPs, typically on a quarterly basis. These are called Distributions.
The chart below shows how this might look in practice: with investments made over 5-6 years with the bulk of the capital deployed in 3 years; Distributions are made in the latter part of the fund life cycle; drawdowns and distributions may be netted off against each other meaning you never actually have to put up the full amount committed.
It’s important to note that VC funds are illiquid investment vehicles, meaning that LPs cannot withdraw their money from the fund until it reaches its scheduled termination date. For this reason, VC funds are best suited for investors with a long-term time horizon who are comfortable with some level of risk.
Conclusion
Venture capital funds can be a great way for high net worth investors to get exposure to cutting-edge companies with high growth potential. But it’s important to understand how these types of investment vehicles work before committing any money. By understanding the commitments and drawdowns involved in VC fund investing, you’ll be in a much better position to make an informed decision about whether or not this type of investment is right for you.
