VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise
Raising a Fund A VC fund is a monetary partnership made up of: –GPs (general partners) are the VCs who actively invest the fund in startups. –LPs: Financial investors with no active role “Institutional”: pension funds, university endowments, insurance companies, etc. Government.
Raising a Fund LP 2 LP 3 LP 4 VC Firm (GPs) Fund 1 $$$$ LP 1 LP n Pledge $$ Commitments only. No actual cash changes hands. Pledge $$
Raising a Fund CalPERS Parish Capital VC Firm (GPs) Fund 1 $$$$ UNC Endowment AIG Pledge $$ Example NC Pension Fund
Example Portfolio Diversity of LP VC is a subset of private equity.
VC Firm vs. VC Fund One firm manages multiple funds: –Firms are LLCs (limited liability companies) with no end date. –Funds are LLPs (limited liability partnerships) with 10-year lifespans. Roizen: small and large firms.
Fund Size Large: –New Enterprise XIII, $2.2B,12 GPs –Kleiner Perkins XIII, $700M Local RTP, for example: –Intersouth IV, $275M –Southern Capitol II, $15M
New Enterprise Associates hauls in nearly $2.5B for new fund 10/19/11: BALTIMORE, MD - New Enterprise Associates has secured commitments for $2,457,680,000 for its NEA 13 fund, targeted at $2.5 billion, according to a regulatory filing. NEA, which focuses on IT and healthcare investments, currently has $8.5 billion under management in 12 funds. Imagine you are a start-up that needs $1M in funding. Can this firm help you?...
Year0510 Fund Life: 10 Years A) Invest and Reserve B,C,D…) Follow-On Rounds Harvest/Exit “Raise” Fund
Example Successful Investment Invest and Reserve Follow-On Rounds Harvest Series A Due Diligence Hit Milestones Hit Milestones Series B EXIT Find Deal Series A ROI is calculated on 6 years Series B ROI is calculated on 3 years
A Pattern That Repeats AA BB Exit
AA BB AA BB Portfolio of Investments AA BB AA BB CC AA BB AA BB Bust AA BB AA AA AA BB CC AA DD BB Exit Big Exit Exit
Source Deals: Network Lawyers, CPAs, CFOs, bankers Other VCs (syndication) Serial entrepreneurs Conferences Universities –Technology transfer –Teach, coach, mentor, judge.
The Wall Street Organization, Inc.
Stages of Equity Funding Friends/Family $1,000-$50,000 Seed or Pre-Seed $25,000-$250,000 Angel or Early Stage $50,000 - $500,000 VC Rounds 1, 2, 3… or A, B, C… (Institutional) $500,000 - $50M IPO
Typical Growth of Bootstrap Venture Normal bootstrap business Grows steadily (if you’re lucky)
Rounds An investment / stock issuance occurs in something called a “round”. VCs purchase preferred shares, which means they have rights over “common”. Most ventures need multiple rounds (Series A, Series B, etc.). Each round dilutes previous shareholders. Valuation occurs at the moment of a round (other times difficult to value illiquid asset).
How Does a Round Work? Pre-Money Valuation + Investment = Post-money Valuation $ $ $$ + =
Example: $3M Post Preferred Shares Common Shares
Negotiating Points Pre-money valuation Investment size Option pool Board seats Liquidation preferences Dividends Anti-dilution Closing conditions Determine % ownership Some of the “rights” of preferred shares
Growing Ventures On the Team –“Active” participation = board seat(s) –Advisors (connections, strategy, etc.) Future rounds –Valuation –Milestones –Syndication
Board Seats Board of directors controls the venture (unlike board of advisors) Small ventures have small boards that meet often (quarterly), 3-7 members Odd number to prevent ties % ownership of stock should be (approximately) reflected in % of board seats –E.g. own 60% of stock, control 3 of 5 seats
Advisors Even if not on board, VCs will have strategic input VC network benefits –Management team additions –Customers –Partners –Competitors
Future Rounds Future rounds are the norm, not the exception (most entrepreneurs do not realize this) VCs help find “syndicate” investors –Later rounds can be much larger –New network benefits Up round: valuation is higher and investment is (usually) higher Down round: valuation is lower
Future Rounds VCs in Series A almost always join Series B –“Pro rata” means they invest to keep same % ownership –aka, “maintain position” In a hits-driven business, not maintaining a position is as bad as no hit –“Last money in” dictates the terms
Series A and B Conflict Series A investor, like the entrepreneur, wants a high pre-money valuation for Series B Series B wants lower pre-money valuation A VC who is in both rounds is trying to find middle ground VCs are generally trying to find a “fair market price” to avoid a future conflicts
Example Up Round Series A: “1 on 1” –$1M Pre-money valuation –$1M Investment → $2M post-money valuation Series B: “2 on 3” –$3M Pre-money –$2M Investment → $5M post-money valuation
Inv = $1M Series ASeries B Post = $5M Pre = $1M Post = $2M Inv = $2M Pre = $3M Shares at $1Shares now $1.5 1M VC shares 1M Founder shares 2M total shares 1.33M Series B shares 2M Series A shares 3.33M shares Ownership Series A VC Shares 1M/2M = 50% Diluted to 1M/3.33M = 30% Series B VC Shares 1.33M/3.33M = 40% Founders Same as Series A VC shares Things go well Hit milestones Increased valuation Up Round: 1 on 1, 2on3
Dilution Original Shares Added Shares New Share Pool Original Shares Same quantity of orange. Lower percentage.
Why Dilution is Bad Original Pool Every 1% you lose of a 20X Exit is going to hurt 20 times more
Inv = $2M Series A Series B Post = $24M Pre = $4M Post = $6M Inv = $12M Pre = $12M Shares at $1 Shares at $2 2M VC shares 4M founders shares 6M total shares 6M Series B shares 6M Series A shares 12M shares Up Round: 2 on 4 12 on 12 Ownership Series A VC Shares 2M/6M = 33% Diluted to 2M/12M = 16.7% Series B VC Shares 6M/12M = 50% Founders 4M/6M = 67% Diluted to 4M/12M=33.3%
Inv = $1M Series ASeries B Post = $2.5M Pre = $1M Post = $2M Inv = $1M Pre = $1.5M 1M shares 2M shares 1.33 shares 2M shares 3.33M shares Shares at $1Shares at $0.75 Remember, these are negotiated (so you start here, then do the math) The rest is math VC ownership after Series B (50% x 1.5/2.5) + 1/2.5 =1.75/2.5 = 70% OR 2.33M shares ÷ 3.33M total = 70% Down Round: 1 on 1 1 on 1.5
Imagine a Scenario The venture needs cash Early round VCs cannot participate (ran out of dry powder) How does this affect negotiations? –Lower pre-money valuation –No ability for earlier VC to take advantage of lower valuation.
Capitalization Table A table that shows the ownership structure of a venture Includes all shareholders and all classes of shares Also called “cap chart” Sign up at for cap chart examples
Example Cap Chart
Option Pool Negotiated, but the norm is to take it out of the founders’ side (or ‘hide’) Result: can severely dilute founders
Inv = $1M Series A Pre = $1M Post = $2M No Option Pool 1M VC shares 1M Founder shares 2M total shares 25% Option Pool Example Inv = $1M Series A Founders Post = $2M 25% Option Pool = 500K shares 1M VC shares 500K Founder shares 2M total shares 500K option shares Option Pool Pre = $1M
Future Rounds Impact on ROI VCs want to “maintain their position” –Keep same % of ownership to exit –Requires “dry powder” for future rounds –Probably need syndication –Trying to avoid dilution You must estimate future funding/dilution to estimate your ROI
VC Return “Top Quartile” venture firms return >20% average ROI to LPs Fund has life of 10 years Average investments are 5-7 years
Startup Invest Startup Portfolio VC Firm (GPs) $$ Fund 1 $$$$ Capital Call $$ LP 2 LP 3 LP 4 LP 1 LP n
Single Exits Home Run dud Triple VC Firm (GPs) Fund 1 $$$$ $$ dud Single Double dud $$$$$ $$ $$$ $ $ $ $$ Single LP 2 LP 3 LP 4 LP 1 LP n
Example Fund 150M fund Fees: 3M/year (salaries, rent, travel) Carry: –12 portfolio ventures at $10M avg. investment –To get 20% ROI, we need ~$450M (20% of 150M = $30M x 10 years) –That’s two ventures going 20X!!
Getting to 20% ROI Rule of thumb: 3X on entire fund However, each investment is not 10 years –Money not “put to work” until a capital call –Exit could happen before end of fund You could reach 20% with only 1.5X
How do GPs/VCs Make Money? Management fee (~2%/year to cover expenses) for 10 years “Carry” –% of capital gain that VCs keep –20% benchmark –Requires liquidity event(s)
Conclusion: VC’s Job Cycle Fundraise 1.Close Fund Source Deals 2.Invest Grow Ventures 3.Exit Fundraise… 1. Close Fund Source Deals 2. Invest Grow Ventures 3. Exit Fund- raise
Understand the “Ecosystem” Fund 1 Fund 3 Fund 2 The game is not “picking the right deal.” It is laying the groundwork for continued success. Raise $ Invest Follow-On Harvest Raise $$$ Invest Follow-On Harvest Raise $$$$ Invest Follow-On Harvest 11 Deals 16 Deals 25 Deals
Key Takeaways Understand the lifecycle of VC job (not just picking deals) Expect future rounds Must have an eye on exit.