#VCMath
A significant part of our role as early-stage VCs is demystifying venture capital for our founders.
We act as translators, converting what VCs say into actionable feedback that founders can use to approach their business and growth strategies differently.
In this newsletter, I'm focusing on #VCMath Like #GirlMath or #DogMath it’s essential to understand.
Before joining a VC fund, I worked in start-ups for almost 10 years. Hundreds of founders I know couldn’t tell you how VC funds make money and the details of VC Fund economics. It’s ok not to know, but not knowing can lead to frustrating conversations where you don’t understand what’s required of you.
Here's a look at how a potential investment decision might unfold:
Before a venture fund even starts deploying capital, they design an investment strategy that they believe will deliver their desired returns. This process is referred to as portfolio construction. As they raise their own fund from LPs (Limited Partners) they share this strategy, which includes things like:
Fund Size
Number of Total Investments
Check Size And/Or Ownership Target
Follow-On Strategy
Once the fund is raised, the firm will start executing on this strategy and managing the portfolio. It’s common knowledge that early-stage investors are assessing a startup’s team, product, early-traction, and the market opportunity. But in addition to those assessment points, investors are also considering:
How much capital they have left to deploy
Their average check size / ownership targets compared with the valuation of the round
Performance of existing companies within their portfolio
Current fund performance against initial investment strategy
As a fund writes more checks, they're constantly monitoring the performance of the portfolio and using that information to inform future investment decisions.
Venture Scale Outcomes
Most startups fail. Very few end up becoming successful, and an even smaller subset become outliers (big acquisitions, unicorns, IPOs).
Given the math required for a VC firm to return their fund, they need to credibly believe that your company has the pathway to reach $100M in ARR or $1B outcome.
Why?
For a $100M early-stage fund, every bet they make needs to have the potential to get them to their (3X - $300M) in returns. For larger funds, $500M+, the math to return their fund is even harder. They need even bigger outcomes across their portfolio This is an oversimplification of how returns work, as funds model out dilution, etc, but is helpful for our example here.
How can this information benefit you?
By grasping the goals of a particular fund, you can determine if they're the right investor for you and tailor your pitch to what their outcomes are (just like in sales).
The most crucial thing to remember is that VC funding is a partnership. They provide capital for you to reach your full potential. The more questions you ask, and the more informed you are about their desired outcomes, the better you can assess if a VC fund is likely to proceed with a deal or view your proposal favorably.
I hate seeing our founders waste time with investors they don’t align with. There is such little transparency about this and founders are often pitching blind to the criteria from the VC side is. This makes it challenging to figure out if you are a “good candidate”. If you do the calculation and the VC pathway does not make sense. You can consider other financing options like debt financing, bootstrapping, and building based on revenues. Traditional VC funding is not the right fit for every company.
We are excited to see more funds build capital-efficient investing strategies, where the assumed strategy is that companies only raise a few million dollars and then grow to a $100-250M exit There’s something out there for every entrepreneur, you just need to know what you’re looking for.
I hope this inspires you to ask more questions during your pitching process. At a minimum trying to figure out the size of the fund, how much capital they have left to deploy, how many checks they are writing, and what their desired percentage ownership is.
If this was helpful to you, spread the love by forwarding it to a friend or two.
See you next time!
Dani Pico
If you're an early-stage B2B SaaS founder building something awesome and looking for your first check and unmatchable support, learn more about our accelerator here, and pitch us here.
If you're an early-stage B2B SaaS founder with an awesome idea and deep domain expertise, and are looking to build with an experienced team, learn more about our venture studiohere, and find out what we’re most excited about here.