Review: #BreakIntoVC

#BreakIntoVC is a pretty great little book. What I got most out of this book was probably an understanding of the structure of VC firms, and how to read financial statements.

The structure of VC firms is pretty standard. VC firms manage multiple funds. Each fund is raised from a number of limited partners (pension funds, university endowments, family offices, etc.) for a period of 10 years. Within the first 3 years, most of the money in the fund is invested and the firm moves on to raising and investing the next fund. At the end of 10 years or when the investments are completely liquidated, the LPs get their money back. The VC firm charges a 2% annual management fee to pay its investment professionals, back office staff and other expense (legal, rental, etc.). On top of this, the firm receives 20% of the profits of the investments (“carried interest”). The returns in the VC asset class are expected to be 30–40% (compared to lower risk private equity asset class returns of 20–30%). Very few firms deliver this. It is estimated that the top 20 firms deliver 80% of the returns in the industry. And hence, they are oversubscribed and often charge 30% carry.

Before this book, I didn’t really understand corporate financial statements and a lot of the terms that get thrown around in business like EBITDA (pronounced ee-bit-ah). As well as the differences between income statements, balance sheets and cash flow statements. Funny story: while PeerCDN was in the process of getting acquired by Yahoo!, I had to make a balance sheet since we didn’t have an accountant (and had no need for one). I listed out our assets and liabilities but forgot to add in equity, so I got a response back from the Yahoo! finance person saying that our balance sheet didn’t balance. I probably caused her to become very skeptical of Yahoo’s acquisition strategy. “Why the fuck are we acquiring companies that don’t even know how to balance a balance sheet??”

Conceptually, re: financial statements/accounting, I used to think about labor costs as one thing: all humans involved in producing a product from designers to assembly line workers making the iPhone. But the COGS (cost of goods sold) vs. R&D vs G&A (general and administrative) vs. selling/marketing spend is a much more meaningful breakdown. Amazon’s a great example of a company that could be making much bigger profits if they did less R&D. So, the fundamentals of the business are solid but if you lumped together various human costs into a single bucket, this would not be obvious.

Timing also matters significantly in accounting. The simple view of money or no money in the bank that we use in everyday life (at least, if you’re young) doesn’t work for companies. When you buy a new MacBook for a couple of thousand dollars, it feels like an immediate spend. But the right way to account for it is to depreciate and write it off over a number of years rather than a single year, because you’ll be using a Macbook for a few years (contrast with a dinner at a Michelin-starred restaurant). Deferred revenue is another one. Let’s say someone pays you money now to do design work in a couple of months. The happy kid answer is that you made a bunch of money, time to celebrate! But in accounting terms, the money you received is both an asset and a liability (so it cancels out in net) because you have yet to complete the work. Once you do that, the liability goes off the record, and now, you really have the money.

The book also does a surface-level overview of various valuation methods. I didn’t find these particularly relevant, because I doubt many of these methods actually matter for early-stage VC. For the most part, seed stage companies are valued by the capital being raised and the desired corporate ownership of the investor. If the startup needs 3 million and the VC wants a 25% stake, the valuation is 12 million post money. Simple enough.

Solid book. Recommend if you’re a startup founder.

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