In the world of venture capital, few terms are as widely recognised - or as frequently debated - as the 2 & 20 model. This traditional fee structure, which includes an annual management fee and carried interest on profits, has long defined how venture capital (VC) firms are compensated.
However, as startups evolve, investor expectations shift, and performance metrics become more transparent, the structure of these fees — and how they compare to those in hedge funds — is increasingly under scrutiny. From understanding the mechanics behind IRR and MOIC to benchmarking fund performance and navigating the differences in incentive compensation, this article explores the nuances of VC economics that every founder and investor should know.
In this guide, we unpack the core components of VC compensation and provide insights into how these models are evolving in a competitive funding environment.
What Is the 2 & 20 Fee Model in Venture Capital?
Two and twenty (2 & 20) refers to a fee structure in which a fund manager (general partner or GP) charges:
A 2% annual management fee on the fund’s committed capital or assets under management (AUM) and
A 20% carried interest (or ‘carry’) on the fund’s profits, payable only after the investors (limited partners or LPs) have received their initial capital back.
The model has been widely adopted across VC, private equity, and hedge funds, providing both stable operational income and performance-based rewards for fund managers.
How Venture Capital Fee Structures Work
Management Fees in Venture Capital
Management fees are the primary source of revenue for a VC fund’s day-to-day operations. These fees typically range from 1.5% to 2.5%, with 2% being the industry benchmark, especially in early-stage funds.
These fees are not designed to generate profit, but rather to cover:
Salaries for investment professionals and support staff
Legal and compliance costs
Office expenses and infrastructure
Travel and deal sourcing activities
The exact terms are detailed in the Limited Partnership Agreement (LPA) - a binding contract between GPs and LPs that governs fund operations, investment strategies, and fee mechanics. Importantly, management fees often decline over time, especially as a fund moves from its investment period into its holding or exit phase.
Carried Interest
Carried interest is a portion of a fund’s profits that is allocated to the GP, typically 20%, although this may vary depending on fund performance or negotiation with LPs. In some cases, GPs must also meet a hurdle rate (e.g., 8% IRR) before they are entitled to carry. This aligns the GP’s interests with those of the LPs by incentivising only successful investments.
The carried interest structure encourages:
Long-term thinking and value creation
A focus on identifying and nurturing high-growth startups
Risk-taking, as GPs are often compensated based on outcomes rather than activity
Retention of key talent within VC firms, as carry is often distributed over years
For investors evaluating a fund’s performance or founders assessing potential backers, understanding how returns are measured is critical. The following metrics are commonly used in venture capital:
Internal Rate of Return (IRR) in VC
IRR measures the annualised rate of return over the life of the investment. In simpler terms, it’s the discount rate that makes the net present value (NPV) of all cash flows (both inflows and outflows) equal to zero.
IRR is especially useful when comparing funds with different investment durations or cash flow timings, offering a time-sensitive snapshot of performance.
Multiple on invested capital (MOIC)
MOIC is a simpler ratio that reflects the total value generated by a fund relative to the capital invested.
Formula: MOIC=Total capital investedTotal value (realised + unrealised)
MOIC is effective for measuring absolute value creation, without taking time into account. For instance, a MOIC of 3x means that the fund returned three times the capital invested.
IRR vs MOIC: Which Metric Tells the Full Story?
The differences between these two metrics are:
MOIC is best for understanding absolute value creation, regardless of time.
IRR is useful for comparing investments with different time horizons or cash flow patterns.
VCs and LPs often use both metrics together to get a comprehensive view of fund performance.
VC Fees vs Hedge Fund Fees: What’s the Difference?
While both VC firms and hedge funds use the 2 & 20 model, the nature of their investments and time horizons differ significantly.
Hedge Fund Incentive Structures
Hedge funds are pooled investment vehicles that employ a variety of strategies - from long/short equity to derivatives - to deliver outsized returns. Their compensation structures are generally as follows:
2% management fee on net asset value (NAV), calculated annually
20% performance fee on profits, sometimes with high-water marks or hurdle rates to protect investors
However, hedge fund fees are more likely to be applied annually, whereas VC carried interest is usually only realised after a multi-year lockup period, often 7 to 10 years.
While hedge fund fees are often criticised for misalignment, VC fees, especially carry, tend to be more performance-aligned with long-term outcomes.
New Trends Reshaping VC Fee Models in 2025
The VC ecosystem is undergoing meaningful shifts that may eventually disrupt the traditional 2 & 20 model.
Fee Compression
In competitive markets, newer and smaller funds may offer reduced management fees or tiered carry structures to attract LPs. In some cases, carry may be deferred or tied to more aggressive hurdle rates.
Performance-based Incentives
There’s growing interest in models where GP compensation scales with performance. For example, instead of a flat 20% carry, GPs might earn:
15% carry up to a 2x return
20% carry between 2x-3x
25% carry above 3x
This rewards outperformers and disincentivises mediocrity.
Africa-specific Considerations
In emerging markets like Africa, investors are experimenting with more flexible fee models that reflect:
Smaller fund sizes
Earlier-stage risk profiles
An extended time to liquidity
Blended finance structures with direct foreign investments (DFIs) and impact investors
In many African-based funds, management fees are structured to account for the intensive support required for early-stage startups, which often need more operational involvement than their Silicon Valley counterparts.
Conclusion: The Future of VC Incentives and Returns
The 2 & 20 model has long served as the default fee structure in venture capital, providing a balance of operational stability and performance-based incentives. However, in an era of growing transparency, changing investor expectations, and evolving startup ecosystems, particularly across Africa, this model is being challenged and adapted.
Whether you're a startup founder negotiating term sheets, an emerging fund manager building your first LPA, or a limited partner evaluating where to deploy capital, understanding how VC firms make money - and how performance is measured - has never been more critical.
As competition intensifies and funding sources diversify, the firms that thrive will be those that embrace innovation not just in deal sourcing—but also in how they align incentives, measure success, and deliver value to both their investors and the startups they back.
Lungile is the Digital Editor for Startup.Africa, with a knack for storytelling, technology and innovative ideas. Working with Startup.Africa, she takes simple ideas and turns them into amazing stories.
Lungile Msomi
