Founders who have raised venture capital and investors who allocate to both asset classes often conflate hedge funds and VC funds — until they look closely at the structural differences. Gurpreet S. Bal works across both structures and is clear about where the confusion originates: "People confuse hedge funds and VC funds until they look at the redemption provisions. One structure has a 10-year lock-up with no exits until a portfolio company liquidity event. The other lets investors walk out the door every quarter. Everything else flows from that."
The structural divergence between hedge funds and venture funds shapes their economics, their investment behavior, and the leverage dynamics on both sides of the relationship.
A hedge fund is open-ended: investors subscribe at regular intervals and, subject to notice and lockup provisions, redeem their interests for cash. This is the opposite of a closed-ended venture fund, where capital is committed at formation, called over time, and returned only when investments are sold. The fund issues new interests with each subscription at current NAV, and redemptions force it to liquidate positions or hold cash reserves, directly linking investor behavior to portfolio management. The capital base is dynamic and never "closes" in the venture sense, which affects position sizing and the manager's ability to hold illiquid assets through a cycle.
The defining feature of a hedge fund is that it is open-ended: investors can subscribe to the fund at regular intervals and, subject to notice and lockup provisions, redeem their interests for cash. This stands in stark contrast to a venture fund, which is closed-ended — capital is committed at formation, called over time, and returned only when investments are sold. A hedge fund issues new shares or partnership interests with each new subscription, priced at current NAV. Redemptions require the fund to liquidate positions or hold cash reserves — creating a direct link between investor behavior and portfolio management. The fund never "closes" in the venture sense. The capital base is dynamic, which affects everything from position sizing to the manager's ability to hold illiquid assets through a market cycle.
The classic "2 and 20" model is a 2% annual management fee on AUM plus a 20% performance fee on profits, though economics have compressed — emerging managers may offer 1.5% management fees and 15–17% performance fees to attract capital. Unlike a venture fund, the management fee is calculated on AUM that fluctuates daily with the market, not on committed or invested capital. Many institutional LPs also require a hurdle rate: a minimum return threshold, often pegged to a risk-free rate or LIBOR-based benchmark, that the fund must exceed before earning a performance fee. The hurdle rate negotiation is often where sophisticated LPs show their leverage most clearly.
The classic hedge fund economics are "2 and 20": a 2% annual management fee on AUM and a 20% performance fee (incentive allocation) on profits. In practice, the economics have compressed significantly. Established funds still command near-2-and-20; emerging managers may offer 1.5% management fees and 15–17% performance fees to attract capital. The management fee in a hedge fund is calculated on AUM — which fluctuates daily with market movements — rather than on committed or invested capital as in a venture fund. Many institutional LPs also require a hurdle rate: a minimum return threshold (often pegged to a risk-free rate or LIBOR-based benchmark) that the fund must exceed before the performance fee is earned. Gurpreet Bal notes that the hurdle rate negotiation is often where sophisticated LPs demonstrate their leverage most clearly.
A high-water mark (HWM) protects investors from paying performance fees twice on the same gains: if a fund falls 20% then recovers, the manager collects no performance fee on the recovery until the fund returns to its prior peak for that particular investor. It is the hedge fund analogue to a venture fund's carried interest waterfall and clawback, but it operates continuously and per-investor rather than as an end-of-fund reconciliation. A fund that suffers large drawdowns and cannot recover above its high-water marks faces an existential problem — the performance fee is effectively suspended and the management fee alone may not cover operating costs.
A high-water mark (HWM) is an investor protection against paying performance fees twice on the same gains. If a fund loses 20% and then recovers 25%, the manager does not collect performance fees on the recovery until the fund has returned to the prior peak — the high-water mark — for that particular investor. In a venture fund, the analogous concept is the carried interest waterfall and clawback provision, which requires the GP to return carry if early distributions exceed what the GP was entitled to on a whole-fund basis. The HWM serves a similar protective function but operates continuously and per-investor, not as an end-of-fund reconciliation. A fund that suffers large drawdowns and cannot recover above its high-water marks faces an existential problem: the performance fee is effectively suspended, and the management fee alone may not cover operating costs, leading to fund closure or restructuring.
Hedge funds holding illiquid assets — private credit, distressed securities, pre-IPO positions — use side pockets to segregate them from the liquid portfolio and remove them from the NAV used for subscriptions and redemptions; new investors get no exposure to existing side pocket assets, and redeeming investors get their pro-rata share back when the position is liquidated. Side pockets prevent forced selling to meet redemptions but reduce transparency and create valuation disputes. Most hedge funds also use leverage borrowed from prime brokers, who lend securities for shorts, provide financing, and often act as custodian — and the prime broker's ability to call margin is a risk with no parallel in a venture fund.
Hedge funds that invest in illiquid assets — private credit, distressed securities, pre-IPO positions — use side pockets to segregate those investments from the liquid portfolio. When an investment is designated as a side pocket, it is removed from the NAV calculation for subscription and redemption purposes. New investors don't get exposure to existing side pocket assets; redeeming investors get their pro-rata share of the side pocket returned when the position is eventually liquidated. Side pockets protect the fund from forced selling to meet redemptions, but they reduce transparency and create disputes over valuation and timing. Unlike venture funds, most hedge funds use leverage — borrowed money from prime brokers to amplify positions. Prime brokerage relationships are a significant operational component: the prime broker lends securities for short positions, provides financing, and often serves as the fund's custodian. The prime broker's ability to call margin is a risk factor that has no parallel in a venture fund structure.
Gurpreet S. Bal is a corporate partner with 16 years advising on private equity, merger transactions, and public offerings for companies and investors at three of the world's top law firms. He has represented clients in hundreds of transactions with aggregate deal value exceeding $60 billion across AI, semiconductors, fintech, and emerging technology. For more information and to get in touch, visit gurpreetbal.com.