Aligned incentives is an investment model where a venture capital firm and its partners are rewarded for working with founding teams to build successful and sustainable companies. It differs from the traditional model, which is focused on raising and returning capital.
At York IE, we think differently about the venture capital market. My co-founders and I have experienced successful exits under the traditional VC model in the past, but we’ve also seen how close they can come to going astray — and they often do.
Most VC firms will tell you that they expect 30% to 40% of their investments to fail, but in reality the figure may be much higher. About 75% of venture-backed startups in the United States never generate returns for their investors, according to Harvard Business School research.
That’s why we take a different approach with aligned incentives.
The Traditional VC Model
With traditional venture capital, if I’m earning a management fee based on the size of the fund, I’m being paid to deploy capital within a specific timeframe, and that capital has a markup or two. That then allows me to go out and raise a bigger fund so that I can earn a bigger management fee. But those markups are nothing but paper returns. I’m making a larger gain on paper, but it’s artificial until it is liquid.
The way the economics end up working in a traditional VC fund, between management and other layered-on fees, plus the netting out of gains and losses, you need one in 10 companies to be an outlier, otherwise, you may not return capital at the return rate that limited partners expect.
How Aligned Incentives Work
With aligned incentives, you don’t need the unicorn. One in 10 would be nice, obviously. But our economics are on a deal-by-deal basis instead of at the fund level, so you can see capital returns right away.
Because of the way we’re set up, we can provide an outsized amount of help to early-stage companies — those that are self-funded, with maybe some friends and family loans or angel investors — in ways that other firms just can’t. We write a check to show that we believe, but we also provide advisory services and serve as an extension of the management team.
Management fees are typically the only source of income to an investor, and they’re not enough to enable firms to build out the kind of team that we have at York IE. A fund can’t build out a team to provide marketing communications services or develop a market intelligence platform, because they don’t see those as revenue-generating positions. But we do, because we as a company — and every individual on our team — are incentivized to help our services clients and portfolio companies succeed.
It’s very easy for founders and entrepreneurs to see that we have the right intentions. And our investors love this aligned incentives model because they know they’re not just paying us to deploy capital. They’re paying us to help build successful companies. By putting the entire breadth of York IE behind each startup, we’re de-risking our investments.
We have strong relationships with VCs and believe in their purpose. But in a large venture capital fund, the client is the limited partner — not the entrepreneur or their startup — and it’s hard for a $50 million exit to be a success. The emergence of syndicates, rolling funds, SPVs and SPACs has shown that the model is ripe for disruption. We want companies to maintain the ability to sell for $50 million and have everyone around the table still be happy. Aligned incentives make that possible.