One Investment to Return the Fund

Hunter Walk has an interesting post up titled Why I Don’t Ask “Is This a Billion Dollar Business?” Before I Invest. In the post, he highlights an important element that I believe most entrepreneurs fail to understand when looking to raise money from VCs: VCs want to believe that they can return the value of the entire fund on a single investment.

Most of the time, when asking entrepreneurs what VCs want, you get the standard response that VCs want to make money. Yes, they want to make money, as do all investors, but they don’t want to make a 20% or 50% return on capital. The goal is to make an investment that generates a 10x or 20x return. Assuming the capital invested was less than 10% of the fund, a 10x or 20x outcome will return the entire fund.

This goal is especially true with smaller funds, which are more and more common. For larger funds, a standard minimum bar is to have an investment return at least 10% of the committed capital (see Ask Prospective Investors About the Ideal Exit). So, if it’s a $200 million fund, the VCs representing the fund would want an exit that returns at least $20 million in cash to the limited partners.

Overall, VC and entrepreneur exit goals often don’t align — remember to set expectations before taking money.

What else? What are some other thoughts around VC expectations being different from entrepreneur expectations?

3 thoughts on “One Investment to Return the Fund

  1. I believe there is often a difference in expectations on the role of the entrepreneur after they raise money. When people give you money, I don’t care if is your Mom, an angel, or a VC, they are going to tell you what to do. You have to listen, but not necessarily take, this advice.

    VCs specifically expect growth. If it is not delivered they will find someone else to spend their money better. For this reason more often than not the founding entrepreneur is not the person running the company by the time it gets to exit. When founding entrepreneurs take venture capital they need to take this into consideration and be willing to settle for a smaller piece of a bigger pie.

    They also might expect some diminished role in terms of scope as the company grows. I have been a part of a company where this expectation was not there, it is not pretty. Entrepreneurs need to heed Cyndi Lauper. Money changes everything.

  2. I’m veering off your points a little but want to mention the investor in a VC fund. As i’m sure you know, VC’s typically charge 2% annually on invested funds with a 20% carry on profits. To paraphrase Warren Buffett on this: he stated that these fees are quite an expense hurdle and therefore it’s not likely that the VC is going to beat index returns..after deducting those hefty fees.

  3. I agree with my friend Lance, many entrepreneurs do not understand that most VC’s will negotiate terms which put the VC in control. Should the business plan falter and things not go well, the entrepreneur often is not flexible enough to adjust his initial idea to changing circumstances or conditions which were not understood at the time of the investment. When VC’s step in and exert this control, often changing the method of execution of strategy, acrimony can result. The timing requirements of the VC should be well understood and the entrepreneur enter the relationship with his/her eyes wide open and aware of what can happen.

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