Are a Venture Capital Firm's Investment-Related Expenses Passed Onto a Startup?

It's all over the map. I've raised money from Venture Capital and Private Equity firms from all regions of the U.S. for various startups and middle market companies that I've been involved in and there is no one, single answer.  Here are the key points...

Generally VCs and PE firm operate under a fee model of charging annual management fees to their limited partner (LP) investors as well as a carried interest on the upside, however some operate as fundless sponsors (mostly later-stage growth or buyout PE shops) and will charge a lot more fees to the portfolio company because of how they structure their fees.

But despite their investment and fee model, many VCs and PEs, will try to get "whatever the market will bear" in terms of fees charged to their portfolio companies.

I've seen some of the bigger brand firms be the most greedy at double dipping by charging portfolio companies simply because they thought they could get away with it. However, that was mostly due to their hubris rather than their skill. LP agreements sometimes will call that out and limit the fees the investment firm is charging the portfolio companies because ultimately it affects the management team's value and the LP's value to the benefit of the VC/PE professionals. FINRA has stepped in as well and clamped down on PE firms charging success fees to portfolio companies for helping them raise or restructure debt.

In most cases, VCs will at least charge travel-related expenses to attend board meetings and in some cases a board fee on top of that. I've also had numerous VCs and nearly all PE firms charge legal and due diligence fees to the portfolio company after closing or even taking those expenses out of closing proceeds.

In one deal, I had three leading VCs involved (all were big brands, all early stage, and all had multi-billion dollar funds) that wired their funds into an escrow account set up by the lead law firm that prepared the preferred investment docs (representing the lead investor) and the law firm netted out their outrageous fees from the escrow first, and then wired me the balance. Then after closing, when the other two VCs found out what happened, they promptly sent me their attorney's invoices because they didn't want to get left out of feeding at the company trough. So, even though the Term Sheet didn't spell it out and I doubt that any of the funds' LPs knew, I was out $250k in the first week. (Part of the issue is that when the fund tells their counsel to send an invoice to a portfolio company, there is zero accountability and the invoice is usually shockingly high.)

I've also seen PEs charge significant management fees to portfolio companies for their "services." The worst was a deal that I ended up walking away from where their fees were not only very high as a starting point, but they escalated each year. Over a typical 5-year investment time horizon, their fees would have amounted to over $2m charged to the company I was negotiating to sell to them, which would have had a significant impact on me and the rest of the management team as we were rolling a fair amount of equity into the new deal. They explained that it was normal for them because of the low fees they charged their LPs - again it had to do with their investment style and fee model.

So, there is no consistent answer, but it is a good thing to clarify at the LOI or Term Sheet stage. It's often a nasty surprise at -- or after -- closing simply because the entrepreneur did not ask about it or was unaware of how it might work.