Recently I was meeting with an entrepreneur who’s out raising a Series A round from VCs. He’s already raised an angel round, built an almost complete version one of the product, and has a handful of customers. Personally, his goal is to build a large successful company, on someone else’s dime, and then do it again on his own timeframe without investors in the future. The clock is ticking now.
When the founder started asking questions about raising money from VCs I quickly asked what his value multiplier was to raise VC money. That is, how much money would he make on his current growth path with an exit in five years vs raising multiple rounds of money from VCs and also exiting in five years. Now, I believe the best companies don’t have an exit strategy but I understand that’s not the standard view.
Here’s a super simple way I think about the value multiplier to raise VC money from a spreadsheet jockey perspective:
- As a co-founder you own 40% of the business with another co-founder that owns 40% and a stock option pool representing 20%
- At the end of five years you still own 40% assuming you don’t raise money and don’t have any dilution
- As a co-founder that owns 40% of the business, assume you raise three rounds of VC financing (roughly one every 18 months). VCs buy approximately 33% of the business with each round of financing and assume the option pool grows by 10%, so multiply the ownership stake by .57 (representing the amount sold to the VCs and the amount for the new option pool, not taking into account liquidity preferences). Here’s the math: .4*.57*.57*.57 which equals 7.4%.
- Assume everything else is equal, which it isn’t, the value multiplier to raise VC money is 5.4. That is, it makes financial sense to raise VC money if the business will be significantly greater than 5.4 times more valuable in five years.
- A quick example: if you can build a company worth $10 million with no VCs, the same company would have to be worth $54 million for the personal gain to be financially equivalent.
Raising VC money creates a number of other opportunities and challenges and shouldn’t be viewed just as money. If it is viewed purely to create more personal wealth then the approximate value multiplier is 5.4 for a five year window.
What else? What are your thoughts on the value multiplier to raise VC money?