In every event I get asked two questions: What is the right valuation for my company and how do I arrive there? How much money should I raise?
Many books have been written about valuation. I’ve got one in my office from my predecessor, about 750 pages thick. I keep it for cold winter nights and the open hearth. Or when I can’t fall asleep. But there are basically three steps you could work on these two questions:
- You know you need $10m to get to the next milestones, but you only want to surrender 30% of the company’s equity. Your pre-money valuation – the valuation before you add the money from the VCs to the pot – is ergo roughly $23m, because the VCs’ $10m of the total post-money of $33m is 30%).
- You realize that a $23m pre-money is probably not what you would expect at no significant revenues with a so-and-so alpha product. So you should seriously think about a lower round and what you could achieve, what that means for the required follow-on rounds, and what impact that might have on scaling, hiring, partnerships, resources, …
- You understand the dynamics of negotiations – from anchors to aspiration points to “Zone of Possible Agreement” (ZOPA) to “Best Alternative to Negotiate an Agreement” (BATNA). You also understand that a private offering satisfies a demand as well as an attitude – a demand and craving by angels and VCs and other investors as well as the risk attitude en vogue. You should read Mark Suster’s post on “Why Startups Should Raise Money at the Top End of Normal” (http://www.cloudave.com/13410/why-startups-should-raise-money-at-the-top-end-of-normal/)
There you are.
The value of portfolio companies in any larger well-reputed VC fund has to be around 70 billion US Dollars. There, I said it. What I mean is that the sum of all exits of the portfolio companies within a fund needs to amount to around 70,000,000,000 US Dollars.
The interest of large venture funds in large exits is not only driven by most of the Sand Hill Road and Page Mill Road VCs’ ability to steer companies successfully towards these exits. As an entrepreneur, I’m a fan of early exits, not the 7 to 12 year drag-along to the IPO with a 180 day lock-in and a spread-out sale of the stock over 3 years.
The way most larger funds work is that silent partners pool money together, with the (sometimes contractual) promise of having anything between 60-90 percent of their deposit invested into high-growth high-risk ventures, at a much-higher-than-market-usual return. Most funds have a run length: After a certain time you get your money back, or the option to convert into a new fund (at a discount). That means that at the end of the fund-period either investments stop (and you get paid back over time), or non-exited companies get sold en block to investment banks and secondary funds.
[Note: corporate VCs are often different in that usually their money is from their corporate mothership only, and are often set up as evergreen funds with no expiration, and often do not need to invest all the money earmarked at all]
While the details of course are not that simple, and there are many other factors, here is a rough calculation that explains the mechanics:
||Required Value of All Exits
|partners deposit funds, amounting to a total of 1 billion US Dollar
|the fund takes a 2% management fee
|the fund “runs” for seven years
|the fund targets a (low) 4x return – or a 22.5% annual interest rate over seven years
|but after a few rounds, VCs might only hold between 10% and 20% of the company’s equity – let’ say 15% – so the 15% of equity has to make back the targeted 4x return + management fee
|if exited, 75% are sales to other companies. Most of these sales are stock transactions, with some cash involved – let’s keep it simply at 40% cash and 60% stocks (as if). In case of an IPO, the VC can hardly sell 15% of the company’s shares right away. Let’s simplify and say until the end of the fund they can also only cash in 40% of their stocks.
So 40% of the exit value at the end of the fund is available to pay back in cash.
Simplified? Yes, of course. There is still a lot of value in the portfolio that gets sold to secondary funds, and lots of value in the stocks. But it gives you an idea why large funds are not interested in your happiness with a $200m exit – because it takes about 345 such exits to make back the $69,000m.