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- There Are No Base Hits in Venture
There Are No Base Hits in Venture
Founder Equity & Fund Economics Explained
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Watch Jason’s pitch on YouTube or listen to the full episode Bevz: A Tech Bro Walks Into a Corner Store…
Ownership is insanely important when you’re fundraising
We have seen this theme play out in multiple episodes of season 10 of The Pitch.
Quick reminder on how fundraising works: when a founder raises money, they’re selling off bits and pieces of the company in exchange for capital.
So an investor might commit $50k in exchange for 5% ownership of an early-stage startup.
Depending on how much the founder raises, and what the valuation of the company is, the founder might close their seed round with about 80% ownership of their own startup.
That’s not too bad. If a founder keeps 80% ownership of a company that is eventually valued at $100m she/he has $80m. That’s a lot of money for anyone.
But as the founder raises subsequent rounds, she/he will continue to own less and less of their startup. By the time the company exits, the founder might own just 10% of their company.
And 10% of $100m is just $10m.
Now, that’s still a lot of money. But a founder who has been grinding and grinding and grinding probably isn’t that motivated to give away 90% of the acquisition money. They might decide to cut their losses halfway in, and start a new company that they have more ownership of.
This is something VCs are very cautious about.
In fact, in season 10, three companies have all run into problems securing investment due to ownership: Bevz, Amateur Golf Society, and Gemist.
For Jason Vego (founder of Bevz), the problem isn’t his current amount of ownership. It’s the amount of ownership he will have after subsequent raises.
Jason Vego, co-founder of Bevz
In Jason’s case, due to the amount he’s raised and the valuation of Bevz, he’s currently at 14% ownership of the company. If he raises again, there’s a real possibility that he’ll have such little stake in the business that he won’t be motivated to keep working on it.
And that’s a concern for VCs. Because VCs need to believe they could get a 100x return on their investment.
Venture capital is a swing-for-the-fences game.
The Billion Dollar Fence. There are no base hits.
VCs don’t grade companies on a scale of “A” to “F”. Every deal is pass or fail.
A venture fund invests in a lot of companies knowing that 90% of them will fail, returning little or no capital back to investors. That means VCs need 1 or 2 huge successes in the portfolio to return the whole fund… plus some.
Let’s play this out: (oversimplified to keep things clear.)
Let’s say a VC with a $10m fund writes a $100k check into a company at a $5m valuation.
Upon first investment, the VC owns 2% of the company
$100,000/$5,000,000 = 2%
Then the company gets acquired for $100m.
Upon exit the VC makes $2m
2% of $100 Million = $2 Million
That sounds like a good return on your money. Unless you have a $10m dollar fund and 90% of your other investments fail.
If that same fund has a company exit at $1B, the VC makes $20 million.
That one deal would return their entire fund at 2X.
(Again, this is an oversimplification. It does not take into account things like discounts, dilution, etc.)
This is why VCs care about big returns. Which is why they care about the founder’s motivation to chase that big return.
Thankfully, Jason was able to get the equity he needed.
Josh Muccio, Jason Vego, Lisa Muccio
Apply to The Pitch Fund to invest in Bevz.
Due to requests we are extending the Gemist syndicate one more week!
Bonus: If you want to learn more about angel investing read How to Get Started as an Angel Investor written in partnership with Hustle Fund.
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Thanks to Kera DeMars at Hustle Fund for her help writing and editing this week’s newsletter. You can find her writing over here.
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