One important consideration for entrepreneurs out raising money is the desired exit size for any given investor. Meaning, all investors want to make great returns, but the size and scale of the desired return varies based on the size and scale of the venture fund. When raising a seed round or small series A from a $25 million fund, if the investor bought in at a $2 million or $3 million valuation and the company sells for $25 million, there’s a good chance everyone will be very happy. Now, if an investor from a $300 million fund bought a small stake in the Series A round and the company sold for $25 million, the investor wouldn’t be happy. Why? Turning $500k into $5 million doesn’t move the needle for a $300 million fund.
Consider the 27x rule for venture fund aggregate investments. It says that for any given fund size, they need an aggregate exit amount equal to 27 times the size of the fund to be top quartile investors — this requires big exits. Similarly, one venture fund I know doesn’t feel it was a quality exit unless they returned at least 10% of the fund back to their LPs (see Ask Prospective Investors About the Ideal Exit). If the average venture fund owns 10% of a portfolio company, and needs to return at least 10% of the fund size to their LPs in the event of an exit, the target for a typical exit needs to be the size of the investor’s fund, or larger.
Entrepreneurs would do well to know that the VC fund size is a good indicator of minimum required exit size for everyone to be happy. The larger the fund, the larger the required exit.
What else? What are some more thoughts on the idea that VC fund size is a good indicator of required exit size?