Recycling
What recycling means, how it works, and common misconceptions.
Recycling is reinvesting realized proceeds into new or existing investments instead of distributing them to LPs. "Management fee recycling" and "recycling of investment proceeds" describe the same practice, just calculated differently.
Why GPs recycle
Brad Feld lays out the incentives at Why VCs Should Recycle Their Management Fees. Recycling lets the fund invest more than it raised, boosting returns. When a fund receives proceeds, instead of distributing, it holds and redeploys them per the LPA. This can meaningfully increase total invested capital and returns.
Primer: AngelList, Venture Capital Fund Recycling.
Fred Wilson, Reserves, Recycling, and Returns:
[Recycling] means that for any given fund, we will keep the returns we get on early smaller exits and put them back into the fund. This increases our reserves capacity but it also means that we invest more money in our portfolios than we raised, including the management fee load. If a $200mm fund can actually invest $250mm and gets a 3x on that $250mm, it generates a 3.75x on the $200mm that was invested by limited partners. That has a hugely positive impact on returns.
Why LPs sometimes decline
LPs may prefer earlier distributions to see realized proceeds sooner, or to allocate less capital to the manager and run their own asset allocation.
Standard LPA terms
The LPA specifies what can be recycled, how much, when in the fund lifecycle, and what portion of proceeds.
Max amount and basis
Typically expressed as a percentage of management fees or of committed capital:
- 100% of management fees — typical
- 20-25% of committed capital — typical; roughly equivalent to 100% of management fees when fees are ~20% of committed capital
Wording can vary. "125% of committed capital" means 25% above committed, equivalent to "25% of committed capital" for recycling purposes.
Funds often can't hit the max because of other LPA restrictions.
When in the lifecycle
LPAs may limit recycling to the investment period or allow it throughout. Allowing later recycling supports follow-ons when you don't want to deploy into new investments late in the fund.
Time from initial investment to exit
Terms may restrict recycling to proceeds from investments made less than N years ago. Goal: focus recycling on early exits.
How much of the proceeds
Options in the LPA:
- Only the amount originally invested
- Amount invested plus allocated cost basis
- All proceeds from the exit
The difference drives whether profits get distributed or recycled.
What recycled capital can fund
Some LPAs restrict recycled capital to new investments only; others allow follow-ons. Combined with time limits, this shapes when recycling can happen.
Common misconceptions
managment fee recycling must be one of the hardest thing for emerging VC managers to understand (based on the amount of emails I get on how to model it)
— taylor (@tdavidson) January 3, 2023
Why is it called "management fee" recycling when proceeds are what's recycled?
Unclear. And in many funds recycling is expressed as a % of committed capital, not fees.
Does this mean the management company makes less money?
No. Recycling doesn't reduce management fees or affect the management company budget.
Do funds only recycle on early exits?
Not always. LPAs may limit it to early exits during the investment period, but others allow broader recycling. Managers can budget for recycling to cover capital calls or future operating expenses.
How is this different from an evergreen fund?
Evergreen funds also recycle, but as open-ended vehicles they typically recycle a much higher percentage over the fund's life.
How do you model it?
Hemrock's venture capital fund models offer options for the typical recycling terms. The models budget invested capital per the investment timeframe and allocation, then calculate how much of the forecasted proceeds can be recycled. Recycled capital adds to the total budgeted invested capital.
Invested capital may exceed committed capital depending on the recycling options.
Notes on the model structure:
- Timing of deployment and holding period drives how much can be recycled.
- Funds using restrictive options often won't hit the target recycling amount. That's normal.
- Default assumption: 25% recycling, so 25% + 100% of committed = 125% invested + recycled.
- Investments made with recycled proceeds are treated the same as new and follow-on investments — same return and timing expectations.
- Metrics use invested capital; recycled proceeds count as invested capital, so gross and net metrics automatically adjust.
- Some managers prefer to budget recycled investments separately (different timeline and returns expectations). That's a customization I've added when needed.