venture capital

Venture Capital Cash Flow

union-square-venturesFred Wilson has an interesting article on VC cash flows and returns on his blog. I have taken his numbers and included the costs to show cash flows and returns from an LP, VC and entrepreneur perspective.

Please click on the picture to see a larger version (UPDATE: I have updated the graph with some additional assumptions based on Fred Wilson’s second article. The previous picture can be found here):

Number of comments:

Capital called and distributions: I have copied these numbers from Fred Wilson’s article for consistency.

Management fee: the management fee that I show in the calculation is, strictly speaking, not correct. However, in total, management fees make up some 20% of capital called (2% per year for 10 years or so). In order to keep Fred Wilson’s cash-flow numbers intact, I have assumed a 20% cost to each capital call. Update: I have taken the management fees from Fred Wilson’s second article. In order to keep the capital call figures from his first article, I have deducted the management fees from returns.

Fees associated with exit: can vary substantially, 2.5% sounds like a reasonable average value

Spread between founders & management vs. VC: If you raise two rounds of VC funding and sell a third of your company each time, then founders and management hold some 45% of the equity (67% * 67% = 45%).

Carried interest: I have assumed 20% carried interest which is the industry standard. Update: I have assumed that carry is only paid out once 1.00 capital has been distributed to LPs.

Please feel free to correct me on the above, should you find any mistakes or oversights. I would be very interested to see a correct model that includes correct management fees, by the way.

UPDATE: While I was writing my article, Fred followed-up his earlier article with a newer one.

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VC Fund Raising Manual – 7 Term Sheet

When you are out VC fund-raising, getting a term sheet from a VC firm is the crystallizing moment of your relationship with that firm. If you sign it, you are very close to getting the funding. But before you sign it, you need to negotiate it.

This article is part of a series, you can find the Index of the VC Fund Raising Manual here.

Negotiating a term sheet is difficult, largely because you don’t know what the real market value of your company actually is. How do you establish that? The VCs see lots of deals, they know the market better than you do. How can you equalize that position? There is only one solution to this problem:

Unless you have multiple term sheets on the table at the same time, you have no way of assessing what the real market value of your company is. Also: being able to walk away from a deal will put you in a much stronger negotiating position.

Imagine it like looking for a new job. Ideally, you want multiple job offers at the same time, so you can choose the best one. It is the same with VC funding.

The secret to successfully raising funding is that all communications that you have with VCs must lead to a point in time where all the different people give you a term sheet. In the best scenario, you get them all on the same day. If not, then you get them in the same week. Getting them all in the same month is most likely too far spaced apart. In order to be able to receive multiple term sheets at the same time, you have to start talking to VCs at the same time. Ideally in the same week. Pursue VCs in parallel, not in sequence.

For all other aspects of how to negotiate a term sheet, I suggest you visit Venture Hacks. I think the picture below speaks more than a 1000 words about how useful that site is for ‘hacking’ a term sheet, enjoy:

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VC Fund Raising Manual – 6 Partner Presentation

The presentation to all partners in a VC firm wil decide whether that firm will issue you a term sheet. This pitch is just as important as the pitch you give to the one partner that you have been working together with for the last few months, if not more important. However, the emphasis of the pitch is different to the first pitch that you gave. The partner pitch has to prevent the partners from saying NO, not to make them actively say YES.

This article is part of a series, you can find the Index of the VC Fund Raising Manual here.

In order to understand why the partner presentation is so important, you need to understand that most VC firms are partnerships. This partnership, an investment partnership, makes the investment decisions as a group. It is extremely common practice that if one partner is really unhappy about a deal, the deal is not done, regardless of what the other partners think.

So, during due diligence, you have made the partner whom you have have been working together with so excited and confident, that now she is happy for you to present to all the other partners. In a sense, she is now your sponsor in that group of people. Also remember that most of the partners will not be experts in your area. The expert is the partner you have been working together with for the last few months. The others are likely to listen to the opinion of the expert in the group, unless they can find some real flaws in what you are pitching.

So, you and your sponsoring partner will walk in the room and you will get to know all the other partners. The partner who is sponsoring you has already been pitching all the other partners about you several times. They are all pretty agreed that the deal you are offering is very exciting. Your job in this pitch is not to convince them that this deal is exciting. They are already excited. Your only job is not to screw it up at this stage. Your job is to prevent one partner vetoing the deal:

So, whatever you do, don’t do any of the following things:

  • No surprises. They might not like whatever it is that you pull out of the hat (well, unless it is good news, e.g. “We just closed our first customer” or “The technology works twice as fast and twice as well as we thought”)
  • Don’t change your pitch. The partners there are sold on your pitch already, never change the winning story.
  • No unnecessary details. Whatever they are, they might not like them. Keep it simple.

Overall, your job is to give the same pitch, removing some of the finer detail, that you gave to the partner who is now sponsoring you.

Focus your attention on the biggest naysayers. One person who dislikes your deal is enough to kill it. Focus your attention on that person and win her over.

Overall, pitching to many partners is like doing a PhD viva. You have already been doing all your work. Your supervisor has proof-read your dissertation and has submitted it with her approval to her peers for peer review. The peers don’t actually need to love your PhD. Or at least not enough to be happy to sponsor it. But if they dislike it, they will make you go back to do some more work. And you really don’t want to do that.

The same is true for VCs. You really don’t want to fail at this stage, after having gone through all the due diligence.

After a successfull partner presentation, the VC firm is likely to offer you a term sheet, which I will talk about in Part 7 of this series. This article is part of a series, you can find the Index of the VC Fund Raising Manual here.

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