Andreessen Horowitz is raising a $20 billion fund. Getting a decent return on this money will be almost impossible. To understand why, we have to look at how venture funds make their money.

How VC’s Make Money

Big funds like a16z lead rounds in a startup, typically from Series A onward.

In a Series A, the lead will usually buy 10-20% of the company. In a later stage round, it’s likely to be less.

At exit, the VC is likely to see 50% dilution. This is because the company continues to raise money throughout its life, which dilutes the prior shareholders.

So at exit, that 20% becomes 10%. And this is a best case scenario — a VC firm often owns less than that.

With those proceeds, the VC’s pay themselves, taking around 20%.

The bare minimum acceptable return on that $20 billion fund is a 3x. That would get them to an 11.6% annual return, which just barely beats the 10.6% average return on the NASDAQ over the last 40 years.

To be clear, this is a crappy return.

Venture funds are illiquid for 10-15 years. They take enormous risks on early stage companies. You should see a lot more than a 1% performance bump.

But 3x is the bare minimum. So, can a16z get there?

Too Much Capital, Too Few Exits

VC’s usually invest a fund over a 2-4 year period. We’ll assume 3 years. They’re likely to exit around 10 yrs later.

The problem is, there aren’t enough exits in any 3 year period to get a return on a $20 billion fund.

Looking at the years from 2014-24, the most cumulative exits in a 3 year period was $1.3 trillion. That was between 2019-21, at the peak of the market.

Remember, a16z owns 10%. So to get that $60 billion in returns, they need to participate in $600 billion of exits!

They’d have to be major investors in half the companies that exit, consistently through a 3 year period. And the 3 year period would need to be a historic bull market like none we’ve ever seen.

Realistically, this is never going to happen.

A16z is very good, but they’re not in every great company. Sequoia, Benchmark, Kleiner and many others are fighting it out, grabbing off quite a few for themselves.

And if we look at more normal 3 year periods, the picture gets a lot worse.

From 2014-24, the average 3 year period produces just $559 billion in exits. Even if a16z were a major investor in every single successful startup, they still wouldn’t be able to get an acceptable return on their $20 billion megafund!

They could wait longer for more exits, sure. But that increases the amount of exits they need to get. Otherwise, their IRR drops.

So Why Is a16z Doing It?

If they can’t make a decent return on this $20 billion monster, why is a16z doing it? Well, that comes down to the other way VC’s make money…

The 20% performance fee is just part of their business model. The other part, perhaps the more important part, is the management fees.

VC’s typically take 2% of the entire fund every year as a management fee. Whether the fund does well or not, they get that money.

With a $20 billion fund, they’ll pull in $400 million in fees every year, guaranteed.

Pretty sweet right? Well, it gets better…

A16z will probably stack these funds. If they deploy the $20 billion monster in 2-3 years, they’ll raise another. And another after that.

In a decade, they could have 4 of these funds running at once. That’s a cool $1.6 billion in management fees every year, whether the funds do well or not.

Starting to make sense?

A16z isn’t the only firm that does this. Most of the multistage funds have raised multibillion dollar vehicles that will struggle to get returns.

But because a16z is one of the biggest names, they’re able to hoard assets on a larger scale.

Wrap-Up

This is no reflection on the skills of the folks at a16z. By all accounts, they work really hard to help founders. Some of the best people in the business work there.

But nobody, not Don Valentine or Don Rickles, can get a return on a $20 billion fund. The math don’t math.

That’s why some funds prefer to stay small. Benchmark has kept its funds in the hundreds of millions.

These guys are legends. They could raise billions of dollars with a couple of phone calls. But they know that getting a return on that money is impossible.

So they don’t do it. I respect that discipline.

As an angel, I’m happy not to have to worry about these problems. That’s part of the joy of being small — you have an opportunity to score giant returns.

“Anyone who says that size does not hurt investment performance is selling.”

Warren Buffett

More on tech:

How to Diligence VC’s

When an Investor Pulls Your Term Sheet

Meet My Latest Investment: Sent.dm

Save Money on Stuff I Use:

Fundrise

This platform lets me diversify my real estate investments so I’m not too exposed to any one market. I’ve invested since 2018 with great returns.

More on Fundrise in this post.

If you decide to invest in Fundrise, you can use this link to get $100 in free bonus shares!

Misfits Market

I’ve used Misfits for years, and it never disappoints! Every fruit and vegetable is organic, super fresh, and packed with flavor!

I wrote a detailed review of Misfits here.

Use this link to sign up and you’ll save $15 on your first order.