November 25, 2022

Black VC Shares Steps To Know If Your Company Can Return A VC Fund

In a recent Twitter thread, Brandon Bryant, partner at the early-stage investment firm, Harlem Capital, broke down the steps every startup should know about VC fund returns.

Venture capitalists (VCs) buy a stake in a founder’s idea, investing in their company’s balance sheet and infrastructure, before exiting. What VCs are aiming for are sufficient returns at an acceptable level of risk. This is because they, too, have investors whose money they need to multiply.

Why should founders care about this?

Bryant explains that by running the math, founders can understand what each investor expects from them.

“This helps the founder keep goals, updates and business decisions aligned with investors. So a founder can now figure out what type of growth is needed to get to that desired exit value of their investors. A founder can now create accurate financial projections and give the investor confidence.”

Running the math can also help founders understand why VCs may pass on investing in their companies.

“Please do the math on your own company to see [if] it can return an investors fund,” tweets Bryant. “And if it can’t – think about increasing your pricing or choosing a similar market that’s bigger.”

Here’s a break down of Bryant’s thread on running the math

How much does your VC need?

VCs have investors who they raise capital from. Typically, VCs agree to return the investment in 7-10 years and multiply it by 2-3. So

For example, if a VC gets $50m, they need to return $150m from its investments.

A fund usually invest 2-3% of it’s fund into each company ($1.25m) 

Run the math

$1.25m for roughly 25 companies for $31.25 for initial checks then save the rest for follow on checks

VC firm’s investment will be the “first check” deposited into the startup’s bank account.

How much ownership is needed to return the fund at exit?

A seed VC typically has a minimum ownership of 5-10% ownership. Let’s go with 8%.

Valuation is determined by check and ownership

$1.25m at 8% ownership is typically an average of $15m post 

Factor in dilution

Remember, other investors will invest in the company to get it to a larger valuation at exit or IPO

Seed investors typically see 40% dilution at exit, so that 8% will be closer to 4.8%

But VCs need to have $50m to return the fund, so

$1.25m at 8% for $15m post

To get to $50m

$50m/4.8% = $1bn~

voilĂ !

Considering all the above calculations, every company the VC fund invests in will need to have $1 billion in value at the exit to be able to return the initial VC fund they’ve received.

Bryant adds that if your company gets a larger fund, it is crucial to know that seed investors will expect it to have a much larger exit value. VC firms are more likely to say no to startups and only invest in 1% or less of the deals they see because they need to believe the company can have $1bn in revenue or $10bn in valuation.

“In most scenarios getting to $100m in rev of 7-10 years is the sweet spot since many companies get acquired or IPO above 10d their rev.”

It is essential that founders do the math themselves to figure out what type of growth will be needed to achieve this amount to give their investors confidence. It will also give the founder an understanding of whether they can return the fund.   

Kumba Kpakima

Kumba Kpakima is a reporter at POCIT. A documentary about the knife crime epidemic in the UK got her a nomination for the UK's #30toWatch Young Journalists of the Year.