Dear SaaStr: Why Do VCs Want To Own So Much When They Invest?

Dear SaaStr: Why Do VCs Want To Own So Much When They Invest?

It’s confusing. Why do VCs need to own “so much”? Why do they often have these specific targets?  Isn’t just making your investors a good return enough?

It’s because it’s really hard for VCs to make enough money otherwise.

To meet its own financial goals, a VC firm has to return at least 3x the amount it invests. And to reach that goal, to simplify, for most VC funds, each investment needs to be able to “return the fund”, i.e. return 1x the entire amount of the fund. Almost all VC firms have this model, that their top winner returns 1x the entire fund.

So let’s break that down for say a $500,000,000 “exit”. That’s a big exit:

  • If a $25m pre-seed fund owned 5%, a $500m exit would “return the fund”.
  • If a $50m seed fund owned 10%, a $500m exit would return the fund.
  • If a $250m Series A fund owned 25%, a $500m exit would return the fund.
  • Etc. etc.

This is a very simple example, ignoring dilution and many other factors. And of course, a $5b IPO would be even “better” than this $500m example. But finding just one $500m startup is hard enough.

Now, in the boom times of late 2020 and 2021, when it seemed like every top SaaS company was a Decacorn ($10B+), not just a unicorn, this math broke down a bit.  Even 2% of a $50B IPO would return a $100m fund.  But with normalized valuations, ownership matters once again,.

This gives you a sense. It’s just too hard to make 1x the total fund size on small ownership, and the larger the fund, the more challenging it gets.  And you can see from this example, why VCs at each of these stages (pre-seed, seed, Series A) try to hit these ownership stakes.

There are other ways to approach the data, and the strategy. But even a small fund needs fairly material ownership to make enough money on anything other than a decacorn.

A bit more here: Why VCs Need Unicorns Just to Survive | SaaStr

Published on June 14, 2022

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