I was catching up with a VC friend the other day and asked him about a company I’d referred to him. They’d passed on the investment (which is of course fine), despite the company meeting basically every investment criteria I knew about the firm. I asked the partner why. His answer was simply — timing and numbers. He said the deal/company was great. They liked it, period. But to be rigorous, they only looked seriously at X deals per quarter … and it was simply one deal too many in Q1.
Now of course, while I’m sure this is 100% true, if it was a chance to invest in Facebook or Workday at $0.50, I think they would have made an exception and taken it to the next level. But it was a good reminder. There are a number of non-obvious learnings about VCs. I’m not a VC and can’t say I know it all. But having pitched quite a few and taken investment from several, and been through 4-5 liquidity events, over 15 years, let me share a few non-obvious learnings that may help you:
1. VCs, as Individuals, Aren’t That Diversified and Don’t Do Very Many Deals. VC firms, as entities, get pretty diversified, and as collective firms, do a fair number of deals. But the average VC partner only does 1-2 deals a year. Just one or two. Yes, that’s more diversified that you as a founder, of course. But not as diversified as you’d think. So their deals really need to work. So they don’t really want to take much risk. It’s one reason why it’s harder to get VCs to take a risk on you than you might think, and why you need to have 100% of your ducks in a row when you pitch.
2. VCs, Even as Individuals, Own More Than You in The Aggregate. VCs often try to own 20% of each portfolio company as a firm. But as individuals, they own a lot too. If the firm owns 20% of each company, and the VC takes 20% of the gains … that’s 4% effective ownership in your company. Multiply that by say 8 investments per VC per fund, that’s 32% effective ownership of one composite company. That’s more than you. Plus those management fees.
3. VCs Have Their Own Investors and Usually Have to Suck Up to Them, Too. VCs have investors, too, just like you — their Limited Partners, or LPs. The very top VCs don’t have to wine-and-dine their LPs. They just pick up checks. But most VCs have to sell up just like you do. In fact, they have to do more of it in some ways, because they probably have to do it to 15-20 core LPs, vs. a founder who just has 1-4 VCs.
4. Mark-to-Market and Valuation Upticks Really Matter to Many VCs, So They Want You to Go Raise a Big Round. VCs of course only make the big money on a big exit. But they make lots of money on management fees too, and to get them, they need to raise multiple funds. To raise another fund, some and probably even most of the track record of the last fund is still going to be illiquid. They’ll value that with the most recent valuations, the latest rounds, of their portfolio companies. Do a round at 2x-3x the price of last one, they can tell their LPs for the next fund how strong the IRR is on this investment as well, even if it’s just paper gains. They can sell this when they raise the next fund, and tap into the management fees, and also, simply continue and grow the firm to the next level. If there isn’t another fund, the firm just becomes a zombie.
5. Small VCs Align With You, But Lowball You. Big VCs Don’t Align As Well, But Can Pay More. Smaller VC vs. Larger VC is one of the most important decisions you’ll make. The smaller the fund, the more aligned with you they are as a founder. They make less in fees, and more on the carry. And more practically, they can’t keep up with the dilution, like you. But because they can’t write the large checks, they need someone else to. And small VCs also need to buy a lot for a small amount. If they can only invest $2-$3m and want to own 15-20% … that pretty much puts a cap on Small VC valuation potential. By contrast, Big VC can write a big check. In fact, they want to. But the return has to be huge to impact the fund. Fire the CEO, fire the founders, dilute you to nothing … just part of the game for a Big Fund VC. But they’ll give you more money to Go Big. Both have Pros and Cons. Pick the one that best matches how you want to grow.
Just some tactical thoughts to help you with investors. You can get the most strategic stuff from TechCrunch et. al.