A Provocative Tweet by Axios Writer Dan Primack

One thing that I think gets lost in the VC vs. non-VC discussion is that VCs don’t need a company to become a “unicorn.” At least not the early-stage VCs. They might want it, but unicorns weren’t really a thing until a few years back, and VCs “settled” for much shorter home runs

— Dan Primack (@danprimack) January 11, 2019

This tweet generated some good responses.  If you are interested in this sort of thing read the whole thread.  I think it’s really important for entrepreneurs to know how a good VC thinks.  Understanding their motivation will help them with their pitch, and who they target.  I highly recommend reading the book Venture Deals by Brad Feld.

VC math is very very difficult.  The Holy Grail is to return 3x the fund size after fees.  Many funds are raising huge funds.  I don’t see how the math is going to work out for them.  Even at the other extreme, the math is hard.  Leo Polovets shows in this tweet.  It is daunting.

$3m fund -> 20 $150k checks. 1.5% average ownership.

Assume no fees, no follow-on, and 66% dilution over time.

Need $1.8b in exit value to return $9m. It’s pretty nuts.

Given power laws, $1.8b in aggregate exits probably means finding a unicorn.

— Leo Polovets (@lpolovets) January 12, 2019

Fred Wilson weighed in and probably will blog about it today.

VC math is ( how much you own * how large the exit is) / (how much you invested). You can do that math at the company level or the fund level

— Fred Wilson (@fredwilson) January 12, 2019

Roger Eherenberg tweeted something that should give VCs pause.

Dan, it does. You’re not thinking about this right. The bar should be, at minimum, 3x net which is 3.5x gross. 3.5x$50m=$175m. One $1b exit at 10% ownership = $100m. Where’s the other $75m coming from? An off-market batting average for sub-$b exits. In real life the PD exit >$1b

— Roger Ehrenberg (@infoarbitrage) January 12, 2019

Angel math is a bit different but I bet it tracks closely. As an angel, you don’t need to worry about fees. Jason Calcanis is a super angel. He tweeted this:

Correct. If you invest at a $5m valuation you can do well with $250-500m exists.

It’s what I do for a living, but it’s very hard work because you have to make a lot of investments (I did 50+ in 2018).

— jason (@Jason) January 12, 2019

David Rose who is an angel in NYC wrote a book about angel investing. Here is how angel math loosely breaks down.

50% of everything you invest in will fail. You will lose everything.
10%-40% will return 1x to 4x. That’s nice but you probably could have done as well in the stock market. Remember, there is a liquidity premium to investing too.
10% has to return 30x. That will give you a 27% IRR.

David Rose does it on ten investments to keep the math simple. The reality is you need to invest a lot. But, each investment doesn’t diversify you, it adds risk.

As long as you are very valuation disciplined, you can make money in the investing game.  Ohio Tech Angels John Huston has a very long conversation with entrepreneurs prior to investing.  They want to invest in a company sub $6MM pre.  They want all the money that will be in the deal to be sitting at the initial table.  Their target exit for the company is $24MM and up.  If the entrepreneur only does one to two rounds of financing, they will make money.  They’ll likely have as much ownership as an entrepreneur that blows his head out and tries to build a unicorn.

At our fund, we don’t just tip our toe in the water.  We commit.  At seed.  We decided to be very different and write big checks in companies we thought could return the entire fund on exit.  We lead deals, unlike a lot of small funds.  As my friend George Havlicek used to say, “We didn’t come to paint.”

We are very valuation disciplined.  We like to invest below $8MM pre.  But, we want the entrepreneur to build a company with enterprise value of a minimum of $150MM.  Using Fred’s math, if we invest $500K at a $6MM post, we own .083% of that company.  Let’s use Leo’s 66% dilution, and we own .05% at exit.  We would return $7.5MM.  Our fund size is $10.75MM, so we need to do that roughly four times to get 3x on our fund.  (my original math was wrong, so I edited it)

When we talk to entrepreneurs, we are really really transparent about the math.

I don’t see the point of raising a fund and writing a $100k-$300k check.  As you see above, the math just doesn’t work out and doesn’t match the risk/reward.  You might feel good being in a lot of deals, but you aren’t making money for yourself or your LPs.  There just aren’t that many billion dollar companies.