Why VC’s don’t care about your business (or how to understand VC’s required return math and what it means for your startup)

  • My company is growing well, why aren’t any VC’s interested?
  • VC’s keep telling me this is a “lifestyle” business, what the hell is that?
  • at the top of the funnel (the companies they are willing to invest in);
  • in the middle of the funnel (how they act while they are board members);
  • and most egregiously at the bottom of the funnel (when thinking about and pushing for exit opportunities.)

The Black Magic Math

  1. They get a percentage of those profits of the fund (carried interest) and hence are pushing to maximize their take.
  2. Secondly, they want to raise another fund in the future, and to do so they will need to court investors (Limited Partners, or LPs); and to best guaranty their likelihood of getting those investors for the next fund, they want this fund to be performing in the top quartile of funds. What does that mean in real terms? A top quartile VC fund returns on average ~20% IRR annually¹. If you compound that for ~7 years (the average amount of time that the money is “out the door” for the investor) you get a Multiple On Investment (MOI) of 3.6x². So, in basic math the VC needs to return 3.6x their entire fund in order to be considered “top quartile”. I.e. a $100M fund needs to return $360M to investors.
Average VC deal size by stage; sourced from Pitchbook data on 26,000 investment rounds.
Percentage of companies that fail before getting to an exit, by stage. Controls for selection bias i.e. the Series A companies are by definition from the 2.4% of Seed’s that made it through. Source
Implied deals required, on average, to get a “win” given average company failure rates at each stage.
Implied investment dollars required to fund all of the investments made in order to get a single winner, by stage of investing. You’ll see that by this metric, Series B is actually the best dollars-based threshold for investing stage. Note: assumes the fund is taking the industry average percentage of the round as the lead (e.g. 30% of the round as a Seed investor)³
Out of all the money the investor puts out the door, how much of it is left when removing all the deals that go to zero?
The return required from the “Good” dollars in the winners in order to 3.6x all the money that went out the door to find those winners.

The Ramifications of the Madness

  1. A VC may not give you the bridge financing you need to get to your next stage of growth and rather let you die, because (in their estimation) you won’t get to the return multiple they need so that money is better spent betting on someone else who could be a 100x.
  2. A VC may fully “check out” of your company, no longer attending your board meetings (or only attending in body not in spirit) → the “zombie board member”
  3. If you have an exit acquisition offer on the table that may be good for you as a founder, and the employees, but won’t get the VC to the return threshold they need, they may push you to not take it and instead talk you into “swinging for the fences.” If you fail while trying that doesn’t matter, because you’re in the failure pile in their mind already.

The Cheat Sheet

The concise version of all the VC return math.
The returns waterfall for an average A Round VC fund. They put ~$14M out the door per winner, which leaves $2.4M left of “good” dollars after company failures, and that $2.4M needs to return $51M to get the fund back to its 3.6x goal; meaning that winning investment needs to be a >20x return.




Investor in Climate Tech, Sustainability, Robotics, AI, Software, and Sustainability applied to Unsexy Industries

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Greg Smithies

Greg Smithies

Investor in Climate Tech, Sustainability, Robotics, AI, Software, and Sustainability applied to Unsexy Industries

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