How Venture Capital Works: Fees, Carry and the Power Law

Venture capital works as a loop: limited partners commit money to a fund, general partners invest it in startups, and the fund returns cash when those companies are sold or go public. Managers typically earn a 2 percent yearly fee and 20 percent of profits. Because a few winners tend to produce most returns, many VCs look for deals that could return the whole fund.

Definition: Venture capital is a form of private equity financing in which a professionally managed fund buys minority stakes in high-growth private companies, expecting most to fail and a few to generate returns large enough to make the whole portfolio profitable.

If you're new to the asset class, start with what venture capital is, which covers who invests, the funding stages, and 2026 market size. This guide follows the money.

How venture capital works: the money flow in five steps

1. LPs commit capital. Pension funds, endowments, foundations, insurers, family offices, and wealthy individuals sign up to invest a set amount in a fund.
2. The GP calls capital as needed. LPs wire money in stages when the general partner needs it for fees and investments.
3. The fund invests in startups. Over roughly five years, the GP backs a portfolio of companies and holds some capital in reserve for follow-on rounds.
4. Companies exit. An acquisition, an IPO, or a secondary sale turns the fund's shares into cash, often many years later.
5. The fund distributes proceeds. Cash flows back through a waterfall: LPs get their capital back first, then profits are split between LPs and the GP.

Simple on paper. The interesting parts are how long each step takes and who gets paid along the way.

Step 1 and 2: LPs commit, and the GP calls capital

A venture fund is usually a limited partnership with a fixed life. The NVCA notes that the standard partnership agreement lasts ten years, with extensions that in practice mean funds often run longer. Carta's 2025 Fund Economics Report puts the median investment period at five years within that term.

LPs don't wire their full commitment on day one. The GP issues capital calls over time, so LPs need to keep cash available to meet each notice under the fund's agreement. GPs invest alongside their LPs: Carta found the median GP commitment is 1.7 percent of fund size. For the legal entities and exemptions behind all this, see our venture capital fund structure guide.

Step 3: How a venture fund picks its investments

At the top of the funnel, venture is a volume business. One of the most cited studies of VC decision-making, a survey of 885 institutional VCs at 681 firms by Paul Gompers, Will Gornall, Steven Kaplan, and Ilya Strebulaev (NBER, 2016), found that firms consider roughly 100 opportunities for each deal they close. About one in four leads to a meeting with management, a third of those reach a partner meeting, about half of those go to due diligence, and about a third of those get a term sheet.

A hundred looks. One check.

The same survey found the median firm closes about four deals a year, and the average deal takes 83 days to close. Deals come mostly from networks: over 30 percent from professional networks, almost 30 percent generated by the investors themselves, 20 percent referred by other investors, 8 percent from portfolio companies, and only 10 percent inbound from founders.

After investing, VCs work to raise the value of their stake. In the survey, 87 percent said they provide strategic guidance, 72 percent connect companies with other investors, 69 percent make customer introductions, and 65 percent give operational guidance. Funds also hold back reserves for follow-on rounds in the companies that are working.

Step 4 and 5: Exits and the distribution waterfall

A fund makes money only when shares become cash. When a portfolio company is acquired or goes public, the fund receives proceeds and distributes them under the limited partnership agreement. In a whole-fund waterfall, LPs first get back all the capital they paid in, sometimes plus a preferred return, and only then does the GP share in profits. Agreements often add a clawback, so the GP returns carry if early payouts turn out to be too generous.

Here's an illustrative worked example for a $100M fund that charges 2 percent a year for five years and 1.5 percent a year for the next five, with no preferred return:

The portfolio returned about 3.6x on the $82.5M actually invested ($300M divided by $82.5M). LPs net 2.6x after fees and carry. That gap is why LPs track net results, using measures such as TVPI, DPI, and IRR, explained in the venture capital fund performance metrics guide.

How venture capital firms get paid: 2 and 20

The fee and carry in the example reflect market norms. According to Carta's 2025 Fund Economics Report:

• Management fee. The median fee is 2 percent during the five-year investment period, and the 75th percentile is 2.5 percent. It pays salaries, rent, and operations. Carta found 81.9 percent of venture funds on its platform step the fee down at least once after the investment period.
• Carried interest. The middle 50 percent of new venture funds pay exactly 20 percent carry. Carry is earned only after LPs get their capital back, plus any preferred return.
• Hurdles are the exception. Only 9.5 percent of funds between $1M and $10M, and 12.4 percent of funds over $100M, have a preferred return.

Fees keep the lights on, whatever the results. Carry is where partners usually make the most money, and it pays only if the fund produces large outcomes.

That split shapes behavior. A manager living on fees is playing a different game from one living on carry, which is the tension in our take on misaligned incentives in venture. More detail is in the venture capital management fees and venture capital carried interest guides.

Why power law returns drive venture capital

Venture returns aren't spread evenly. They're concentrated. In Andreessen Horowitz's 2015 analysis of Horsley Bridge data on hundreds of venture funds since 1985, about 6 percent of investments, representing 4.5 percent of dollars invested, produced about 60 percent of total returns. Great funds actually lost money on deals more often than merely good funds, but their home runs were far bigger: about 70x on average, against about 20x.

Two rules of thumb follow:

1. Each investment should be able to return the fund. A $100M fund that owns 10 percent of a company at exit needs a $1B sale just to get $100M back. That's one reason VCs ask about market size early, and why a $50M acquisition that changes a founder's life barely registers for the fund.
2. Results vary enormously by manager. Carta's Q1 2026 fund performance report, based on 2,775 funds, found that for every vintage from 2017 through 2024 except 2021, the 90th percentile net IRR is above 20 percent, while the 75th percentile is no higher than 15.5 percent in any of them. In our view, a small group of funds earns much of the asset class's reputation.

"But venture returned 21 percent last year"

It did, on paper. Cambridge Associates' US Venture Capital Index returned 21.1 percent in calendar 2025, its best year since 2021, against 8.7 percent for its US Private Equity Index.

But Cash is another matter. Carta's Q1 2026 report found that fewer than 20 percent of 2017 and 2018 vintage funds had reached 1x DPI, meaning they had returned at least the capital LPs paid in, and median DPI for 2019 and 2020 funds was barely above zero.

Exits are starting to change that, but unevenly. The Q2 2026 PitchBook-NVCA Venture Monitor estimates 874 US venture-backed exits worth about $2.19 trillion in the first half of 2026, a total dominated by the SpaceX IPO. Fundraising is concentrated too, with three firms taking 48.1 percent of the $72.4 billion US funds raised in the first half.

How venture capital works in 2026: what it means for you

For founders, our read is that investors with strong exits can raise and deploy quickly, while many others are cautious. Ask a prospective investor where their fund is in its cycle. The answer tells you a lot about follow-on money.

For new investors, it's a reminder that the loop can take a decade or more to close. Marks move every quarter. Cash moves when companies exit.

Learning how venture capital works from the inside

Most individuals enter venture as angel investors, using the same instruments and power law math at much smaller check sizes. Participation in private rounds generally requires accredited investor status, which the SEC's investor bulletin defines for individuals by income (over $200,000, or $300,000 with a spouse or spousal equivalent, in each of the prior two years), net worth (over $1 million excluding a primary residence), or certain licenses (Series 7, 65, or 82).

The programs that teach this work run on the same requirement. 1752vc's Emerging Angels program is built for accredited investors making their first angel investments, and its eight live weeks put them in a working fund's process rather than beside it: diligence calls and deal reviews, then monthly Investment Circles where the power law math above gets applied to companies on the table. Founders who want the other side of the table can read the founder's primer on how VC funds are structured.

The bottom line

Venture is a ten-year loop built on a handful of outcomes. Fees pay for the machine, carry pays for the wins, and LPs wait a long time to see which one they funded.

The marks say how a fund is doing.

The wires say how it did.

Key takeaways

• Venture capital works as a loop: LPs commit capital, GPs call and invest it, companies exit, and proceeds flow back through a waterfall.
• Carta's 2025 data shows a median 2 percent management fee and 20 percent carry, with 81.9 percent of funds stepping fees down.
• In the worked example, a $100M fund that returns $300M nets LPs 2.6x after $17.5M of fees and $40M of carry.
• VCs see about 100 opportunities per closed deal and close about four deals a year, according to the Gompers, Gornall, Kaplan, and Strebulaev survey.
• Returns tend to follow a power law: about 6 percent of investments produced about 60 percent of returns in a16z's analysis of Horsley Bridge data.

Frequently asked questions

How does venture capital work in simple terms?

Investors called limited partners give money to a fund run by general partners. The general partners buy stakes in young companies, help them grow, and sell those stakes years later through acquisitions or IPOs. The fund keeps a management fee and a share of profits, and returns the rest of the proceeds to the limited partners.

What is 2 and 20 in venture capital?

It is shorthand for standard fund economics: a 2 percent annual management fee and a 20 percent share of profits, called carried interest. Carta's 2025 Fund Economics Report found 2 percent is the median fee during the investment period and the middle half of new funds charge exactly 20 percent carry. Most funds step the fee down later.

How do venture capital funds return money to investors?

When a portfolio company is sold, goes public, or its shares are sold in a secondary, the fund receives cash and distributes it under the partnership agreement. Typically LPs first get back all the capital they paid in, then profits are split, usually 80 percent to LPs and 20 percent to the GP as carried interest.

How long does a venture capital fund last?

A typical venture fund has a ten-year term, with extensions that often stretch it longer, according to the NVCA. Carta reports a median five-year investment period for new investments, after which the fund focuses on follow-on rounds and exits. Cash returns can take most of that decade to arrive.

Do venture capital funds make good returns?

Some do, but results vary widely. Cambridge Associates' US Venture Capital Index returned 21.1 percent in 2025. Carta's Q1 2026 data shows 90th percentile net IRRs above 20 percent for most recent vintages, while 75th percentile IRRs are no higher than 15.5 percent, and fewer than 20 percent of 2017 and 2018 funds have returned 1x in cash.

Sources

• Carta: 2025 Fund Economics Report
• NBER: How Do Venture Capitalists Make Decisions? (working paper w22587)
• Andreessen Horowitz: Performance Data and the Babe Ruth Effect in Venture Capital
• Carta: VC Fund Performance, Q1 2026
• Cambridge Associates: US PE/VC Benchmark Commentary, Calendar Year 2025
• NVCA: Q2 2026 PitchBook-NVCA Venture Monitor (PDF)
• NVCA: What Is Venture Capital?
• Investor.gov (SEC): Accredited Investors, Updated Investor Bulletin