107 points by gtzi 6 months ago
"(investors aim at an ownership percentage and are willing to pay what will get them there)"
What is the reason for this?
I believe investors aim at ownership percentages at Series A mainly for pro-rata.
Lead Series A investors usually get pro-rata rights. Generally, the wisdom in startup investment is to double down on your winners and you typically can only do so if you have pro-rata rights. In other words, if the startup does super well, that VC will likely invest 10x more in real dollar terms to upkeep their pro-rata.
Take 2 pretend funds:
CoolVC has a 20% target ownership and CheapVC has a 10% target ownership. They do their pro rata every round.
Rocketship Corp. will have the following rounds (super simplified):
Series A @ $25M post-money
Series B @ $100M post-money (15% dilution)
Series C @ $600M post-money (10% dilution)
Series D @ $3B post-money (5% dilution)
Series E @ $5B post-money (5% dilution)
Exit @ $9B
CoolVC would have exited with $1.8B + spent $100M (profit $1.7B)
CheapVC would have exited with $900M + spent $50M (profit $850M)
In other words, for an additional $2.5M in the Series A, CoolVC bought an option that would ultimately make $850M more in real dollars than CheapVC.
In the VC world where 1 needle in the haystack makes or breaks your fund, it's an inexpensive option. At Series A, there should still be at least 50X potential upside.
Why do most VC funds target 15-20% ownership? Probably that's probably the most they should get to balance founder ownership through further dilutive rounds. If you look at my above example, remember that founders will probably own less than 36% of the company (they also will get diluted by employee incentive plans).
That's a fantastic explainer, thank you. In general, VC is by nature a game of ownership.
I think that paragraph is somewhat confusing for the intended audience.
Anyways, VCs at series A want to buy enough equity percentage (e.g. 15% to 25% ownership) to make their exit numbers work. Investing a smaller amount to only get 5% of a company is not a "meaningful percentage" or "meaningful stake". (In contrast, YC does buy a smaller 7% equity but their $150k isn't considered "Series A".)
To me, talking about investment scenarios in terms of "valuation" always seemed to make things more difficult to understand. The following math is equivalent but I think the explicit percentages layout is easier to grasp in a few seconds:
Mark Z is considering 2 offers of investments for his young Facebook startup in 2005:
Don Graham offers $6 million at a $60 million post money valuation.
Accel Partners offers $12.7 million at a $80 million post money valuation
Don Graham offers $6 million for 10% of the company
Accel Partners offers $12.7 million for 15.7% of the company
Yes that is what they say ("make exit numbers work") but the math is elastic here so, that explanation does not check out, or at least something is missing.
When investors raise their funds, they pitch a specific model to their LPs.
"We're going to invest in a basket of startups whose aggregate value will be $X billion in 5 years and we will own Y% of those companies at that time."
If they can't hit that Y number, they are not doing what they said they'd do.
Most lead investors at the series A level look to take a board seat, and spend a lot more time per-company than at the seed round.
There's a finite amount of time in an investor's day, and somewhere around 20% ownership of a company is, for whatever reason, considered the magic number where it's worth it to spend that much time with them (through assistance, board meetings, etc).
Calculations that help them understand their possible returns on a company & fund level
The guide is simplistic and wildly overly optimistic -- a founder raising a Series A could not expect such fast progress, e.g., weeks.
Much more realistic and prudent are the common advice and reports of reality that fund raising is difficult and challenging, a full time job, with effort so large it is a risk to the startup, contacting hundreds of VCs, straining to get warm introductions, taking dozens, maybe 100+, of in person meetings, for just one check, much less several, and months of time.
The firm is asking way too much in time, effort, and expenses from the founder, e.g., flying to meetings with VCs. A founder would need a significant source of funds just to apply as described.
There is the pitch deck with more advice that is challenging but obscure. Bluntly, there are NO good guidelines, many guidelines that vary wildly and no good guidelines, for what should be in a pitch deck. As a result, if the VCs need something other than just a good version, well organized, with the information clear, the spelling correct, of a business document, then they are looking for something founders have no way to supply.
Many VCs seem to want and expect to be swept off their feet by some block buster summer popcorn movie, but any such production is way too expensive in time, money, and effort for a Series A and close to irrelevant for serious business and financial work.
The firm is basically asking that the founder have a going business, at least traction and, to be realistic, likely earnings. Given the earnings, there is considerable question if the founder needs or should accept an equity check.
E.g., in the past, a Web site startup needed big bucks for Sun servers, etc. No more: $2000 in parts will build a very powerful server and the cloud can supply a lot of pay as you go server computing right away.
Given the traction of the startup,
the firm thinks WAY to much of the importance of their check. The OP has the simplistic notion that the VC check will be the crucial enabler for future rapid growth; that view is in strong conflict with how successful businesses commonly grow.
Net, the firm, for the whole process, is asking WAY too much and giving and doing WAY too little.
Heavily that view of a Series A is from a dream version of the VC industry from 10+ years ago. That part of VC is gone with the wind. There is still lots of opportunity to make money in information technology startups, but ideas as simple and profitable as, e.g., Hotmail, are long gone.
IMHO, computer science and VC funded startups are out of sufficiently good new ideas, out of gas, at the end of the road. For computer science, programming language syntax, parsing, compiling, linking, fundamental algorithms, database, TCP/IP, etc. are rock solidly done work, but computer science doesn't know what to do next. Similarly for VC -- projects as simple as Hotmail are done. There is more to do and very much worth doing, but computer science and the VCs need to find some new directions.
Again, once again, over again, yet again, one more time, we find that VCs who desperately need very rare and very exceptional projects are proceeding with simplistic attitudes no more serious than a family shopping for a standard SUV.
There is a lot of very serious work in our economy in research, engineering, law, medicine, national security, and parts of finance, but Sand Hill Road and the OP are not nearly serious enough.
In the end, instead of the OP, a founder of a rapidly growing startup should consider the common advice that they should just wait until a VC notices the startup and contacts the founder. In the meanwhile, the founder should just keep working on the business.
I upvoted your comment because you make some good points, but I lost you towards the end there when you boldly proclaim that we're out of good, big, impactful ideas.
There is so much great work being done if you just look around a little bit. The advances in computation photography this decade are incredible. AR will be ubiquitous soon enough. VR has a chance to change how we communicate. There's autonomous sailing drones scouring the seas and mapping them out, streaming data back. There's tiny low cost satellites being launched frequently to image the planet. There's rapid progress on electric transportation in full swing.
There's a lot of these areas that are funded in part by VC. The very nature of VC ensures that the quality of firms also follows the power law so it's not surprise that a majority of funds lack imagination. But if you look at the really great firms, they're still investing in big ideas. Sure they may not be the lowest hanging fruit in the field as you mention, but they aren't precluded from being big, or impactful ideas driven by technology.
Yes, some of the photography is amazing. Part of the success is from some optics math on depth of field -- better with small cameras, and the solid state sensors permit that. E.g., the old idea was just a pinhole camera that didn't have to focus at all. Then the electronics and software processing the signal from the sensor can make the new, really small cameras look really smart. And you may have still more advanced work in mind.
For AR and VR, I see some markets but am reluctant to expect wide usage.
The last really big idea was, what, Facebook? I know: There have been a lot of $1+ billion exits since the start of Facebook, but I haven't kept up on the small fry!!!
I started my career near DC in applied math and computing and there saw a lot of fantastic national security projects from research. E.g., I was in the group that did the Navy's version of GPS, before the USAF did GPS. There was some really nice math, physics, and research, powerful stuff, in that group. E.g., how to design a satellite that will orbit the earth not very high up and have essentially no "drag" at all? Cute. Important.
In an important sense, GPS, etc., are information technology (IT), but from all I can see the role of applied math, physics, and research so heavily used by US national security is missing from Sand Hill Road funded IT projects. E.g., if I were looking for some promising background at Stanford, I'd go to D. Luenberger, B. Efron, or P. Diaconis and not the computer science department. At Berkeley I would have gone to one of my favorite authors, L. Breiman, but of course eventually the computer science people did that to some significant extent.
For Breiman's boosting and bagging, I suspect some important connections with resampling and some math in a paper I published. I suspect that there is a nice, more powerful, valuable way to explain such ideas, maybe with connections with sufficient statistics. E.g., order statistics are always sufficient. But such things are not relevant to my startup and, thus, on the back burner.
Bluntly the US DoD, NSF, NIH, etc. eagerly support and exploit research with a batting average much higher than VCs, while as best as I can see Sand Hill Road, for IT projects, hearing research, soils their clothes and runs to the rest room. It appears that Sand Hill Road believes that the "technology" in IT is mostly just software with no connections with anything new, correct, and significant from research. Yes, they are pursuing AI and ML, but my view is that those are not very promising directions.
The VCs need stuff that, among other things, is NEW, and we know where the "new, significant, and correct" stuff comes from -- research. So far Sand Hill Road for IT (but not for bio-medical technology) has with great determination refused to have anything to do with research, even if already done, rock solid, in production quality code. So the VCs just want to see traction, significant and growing quickly "up and to the right". But the research is a crucial part of estimating the future of the company, past current traction.
IMHO, Sand Hill Road needs to get serious about "new, correct, significant", powerful and valuable in IT.
Hi graycat, I'm the author of the guide. You refer to a number of issues, I'll try to reply to some of them:
- 'Fast' progress, i.e. weeks (I mentioned a couple months as your target): If a deal is hot, things can happen even faster. If you don't have progress within such timeframe, chances are the round is not moving forward at all.
- 'Full time job', 100+ meetings, months of time: If you take a closer lok, we are not necessarily in disagreement with this.
- Requests from the founder: This guide does not describe what we 'ask' from the founders of our portfolio companies, but addresses a much broader audience. Indicatively, we make intros to ~30 relevant VCs in each case and book initial meetings/calls, then the founders take over.
- I agree that advice varies on the internet with regards to what makes a good pitch deck. It is also subjective at some extent. I provided a very high level guidance (and definitely did not request a blockbuster movie production)... At the same time, the deck is what will help you make it through the first stages of the funnel; its importance should be straightforward.
- Re traction requests: VC requirements and the definition of a Series A round may vary per geography, industry or firm (or even per case); what I'm trying to stress here is that such reqs differ compared to a Seed round (i.e. "we want to build this" vs. "here is something that works and we want to go faster")
I hope the above clarify things further. Thanks for your comment!
I can be more specific:
> If you raised a Seed round, sooner or
later you’ll be fund raising – again.
This statement is very eager just to
assume that each successful information
technology (IT) startup will, naturally,
of course, be doing round after round of
I've been to enough yacht clubs to see a
lot of people who have done really well in
business but never accepted an equity
Yes, there is the view that a startup is
necessarily some solid fueled rocket on a
10 G acceleration into orbit or bust, but
that situation is rare in business. The
last one was, what, Facebook? I'm
reluctant to count AirBnB or Uber due to
the risk of their being regulated out of
> sooner or later you’ll be fund raising –
Hopefully not and maybe not: For some
really good projects, e.g., Plenty of
Fish, maybe won't need the funds. For a
business that grew to pre-tax earnings of
$20 million a year, maybe the growth is
then too slow to attract VCs. Or maybe
the business is about to fail.
Or, "sooner or later you will" see a
dentist but not necessarily a VC.
> A core part of a CEO’s job is to secure
the resources for your team to execute the
But for a startup with the traction that
it appears is coveted by VCs for a Series
A, those "resources" might be available
from the seed round or organically, that
is, from current revenue.
> You should expect that you will be
spending a significant part of your time
on fund raising-related issues going
Hopefully, maybe not: Maybe there are
plenty of funds from the seed round or
> At the same time, being successful in
fund raising is a big part of building a
successful company – there is no shortcut
or workaround, and this is not time
There is a "workaround": have a startup
that doesn't need equity funding.
> Fund raising is about being religious in
doing the small things right; as long as
you establish a discipline about it,
things become straightforward.
On the one hand, it is commonly accepted
that running a new business is running at
full speed all the time, putting low
priority work on the back burner or the
trash and doing the most important things
In that situation, there's not a lot of
opportunity to be:
"religious in doing the small things
That perfectionistic work approach may
have been crucial for some of the tricky
core code of the startup. But for
candidate investors to ask the founder of
a promising IT startup far enough along to
get a Series A to be so perfectionistic
is, as I wrote, "asking too much".
> i) Deck – This should include some
context about the problem (why it’s big),
your approach (why it’s unique), your team
(why you’re the ones), early validation
(how it’s winning), next steps (where
you’ll be in a year or two) and grand
vision (your version of the world). It
should be easy to read and appealing
enough to get you a meeting.
If the only goal is a meeting, okay, do
whatever gets the meeting and leave
everything else important for later.
But some VCs don't like superficial decks
just as a teaser to get a meeting and want
enough to know to write a check or at
least to get quite serious. Maybe when
they say that they really are looking for
educational materials to contribute to
their "deep domain knowledge", but maybe
they are serious and don't want a deck
that is just superficial and raised
questions instead of answering them.
I can believe that for a Series A a large
fraction of VCs will need just the name of
the startup so that they can try the
product or service. Or, "don't TELL me;
SHOW me", and with that common advice a
pitch deck is not very promising.
But I was struck by the
"your approach (why it’s unique)"
sounds superficial. E.g., "unique"
doesn't mean much. My view is that the
"approach" is likely -- now needs to be --
the crucial core of the business, its
ability to please the customers/users, to
be difficult to duplicate or equal, and to
provide a Buffett moat barrier to entry.
So the "approach" needs a lot of
attention; it might need a 50 page paper
of original applied math and an NDA. So,
okay, can't have the 50 pages or get an
NDA in the first foil deck, but
still sounds superficial or, worse, that
the VCs are not used to really serious
work on "approach".
Or, I have this terrific idea for a
startup: An airline that flies NY to
Sidney at Mach 15 for $100 per passenger.
The market is huge. The idea is "unique".
Only problem: How to make money at only
$100 a person and, really, how the heck to
fly from NY to Sidney at Mach 15 at all.
Or, it's easy to come up with fantastic
ideas if we don't take fully seriously the
> A budget for the next couple years
How about, we have some cash in the bank,
enough for a rainy day, week, month, or
quarter (IIRC early on Gates wanted enough
such cash for a year of zero revenue), and
otherwise we spend money depending on
current revenue and slowly enough not to
dip into that cash. So, we don't really
have a budget and instead have a
dynamic, feedback control for the
uncertain future. Or, since our rapidly
growing startup is facing unexpected
problems weekly or so, we don't know the
revenue or unexpected expenses and, thus,
can't fix a budget. Or, such a budget
would be like asking a football
quarterback to call all 4 plays on first
and 10. Instead he calls the second down
play after seeing the results of the first
Or, my Ph.D. dissertation was in
stochastic optimal control, best decision
making over time under uncertainty. There
it was more solid than granite clad in
cast iron and Kryptonite that fixed plans
in the face of an uncertain future
commonly are very poor controls.
Sure, the founder knows his on-going
monthly expenses and his revenue in recent
months and the growth in revenue but,
still, he may not have such a budget, may
never have bothered to develop one.
Really, that budget sounds like a lot to
ask of a very busy founder and not much
help for the VC. Or, what founder wants
to report to a BoD with VCs who would take
such a budget seriously?
> List – A list of all investors you want
to go after, to be used in a fashion
similar to a CRM (i.e., track progress
across the pipeline, etc.); these are
either leads you’ve been in touch with, or
new ones you and your partners will be
reaching out to.
From all I've seen, commonly VCs take
great pride in being really difficult to
get to respond at all. E.g., a "cold
contact" can be treated as contemptible
"over the transom" with some scatological
implications. Or a founder who sends a
deck to INFO@VCxyz.COM, if the deck is
noticed at all, puts the founder on the
dunce list. That is, the e-mail address
INFO@VCxyz.COM is a honey pot for fools.
Sure, for the list, go to the National
Venture Capital Association (NVCA) and get
a copy of their membership list. Presto.
Bingo. Done. But to what end?
> make sure that everything is top-notch
So, we're back into this perfectionism
stuff. Commonly "top-notch" is not so
much good work as a sign of the anxiety
disease OCD. My wife was really good at
doing "top-notch": Valedictorian, Summa
cum Laude, Woodrow Wilson fellow, NSF
fellow (two years support in one award),
PBK, top research university from world
famous professors Ph.D. It was fatal:
She never recovered, and missing her body
was found floating in a lake. I have a
good pure/applied math Ph.D. from a world
class research university and, thus, know
what "top-notch" work really is; I doubt
that many VCs do know.
> Do the pitch to 3-4 friendly VCs that
are not top of your list to make sure your
narrative is clear and well-received, or
fix any weak points that may occur (if the
reception is not enthusiastic, you need to
take a step back and iterate until it
Where does a startup founder find "3-4
friendly VCs" when sending 100 copies of
the pitch deck may result in 0-2
For the "fix any weak points that may
occur if the reception is not
enthusiastic", that's asking that VCs be
"enthusiastic", and that was the source of
my parody that the desire is a pitch deck
like a summer blockbuster popcorn movie.
I'm not sure even Spielberg and Lucas
could develop a deck that would get VCs
From such considerations I repeated the
common advice that a startup that might
want a Series A might just f'get about
VCs, concentrate on growing the business,
and let VCs discover the company and show
their interest by contacting the founder.
E.g., some months ago at AVC.COM Fred
Wilson told the story of a startup his
firm USV pursued for some months and
finally talked the founder into accepting
a USV equity check.