David Cummings on Startups

Investment Strategy for a $20 Million Fund

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David Cummings

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Urvaksh broke the news about Valor Ventures last week with his article New Atlanta VC Fund Will Invest in Women’s Companies. I’m an investor in the fund and excited about helping female founders build large companies. Thinking about a $20 million venture fund, here’s a common investment strategy:

  • Allocate 40% of the fund ($8 million) for new investments and reserve 60% for follow-on investments
  • Invest an average of $1 million per company with a target ownership of 20% (results in an average post-money valuation of $5 million) and eight total investments
  • After dilution in subsequent rounds, and participating pro rata in the “winners”, own an average of 10% across the eight investments
  • To achieve a 17% IRR (needed to be top quartile), the fund needs to return 3x cash on cash, which is ~$70 million of cash (inclusive of management fees)
  • Owning an average of 10% of eight companies means the portfolio of investments needs to have an aggregate exit value of $700 million

The venture model is predicated on finding startups that have the opportunity to become large, meaningful companies. Picking great entrepreneurs in great markets is the key to any successful fund.

What else? What are some other thoughts on the common investment strategy for a $20 million fund?

Comments

2 responses to “Investment Strategy for a $20 Million Fund”

  1. Suleman Ali Avatar
    Suleman Ali

    David,

    It seems crazy to me for a $20M fund to only invest in 8 companies, especially early stage companies. That’s just not enough companies. I’d want to invest in 20-25 companies.

    Why make such a small number of bets?

    Reply
  2. Tom Herring Avatar
    Tom Herring

    Having spent time as a GP with a large VC fund, here are what I see as the problems with this oversimplified VC fund analysis.

    8 companies is too small a number of companies to invest in. The odds at that level are very high that you won’t even return the fund, or would have a much lower IRR. A more appropriate number would be at least twice that.

    Management fees would probably average 1.25-1.5% of the aggregate fund size over the 8-10 year life of the fund. This would reduce investable funds by $2-3M over the life of the fund. The actual investment model would be more like 40%/40% after management fees.

    Using his model, realizing  $700M on 8 companies with an average investment of $2+M/company would mean each company would need to average an approximate 40-45x cash-on-cash return. Of course that won’t happen, which means the return on the companies that actually have exits will have to be much higher. This is why you need to spread the investment risk over more companies.

    One of the problems with people looking at the VC business from the outside is the significant lack of visibility into a fund’s business. You never hear or read about the failures. They don’t show up on their Web site, other than when the original investment(s) are made. If they fail, they just go quietly into the night.

    Reply

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