VCs often have target ownership percentages that are driven by two things: 1) ability for each investment to return 100%, 50% or 25% of their entire VC fund and 2) a VC can only be effective on so many boards; so may as well join the board of the companies where they own a meaningful amount of equity.
Many VCs have a minimum ownership percentage they target when making investments. Depending on the stage the VC invests at and their strategy it is often seeking to own at least 20% of the company when leading a Series A investment, buying 10% of the company in a Series B when the A investors want half of the B round and maybe 5% of the company when joining a syndicate of a few different investors in a Series C. Many VCs will want to take 20% regardless of stage and walk away from an A, B or C round if they can not buy at least 20% or 15% of the company at that time. In ancient times (80’s, 90’s and early 2000’s) these numbers were a bit bigger with VCs seeking to own 33% minimum and even lifting that up to 45%. With the power in recent years moving from the investor to the entrepreneur the amount a startup is willing to sell in a single round has gravitated downwards to 20% and goes up a bit to make room for many elbowing VCs trying to get in. With the macro economy cooling things off we may see startups moving back to selling a third in a single financing again as a new baseline.
It used to be that one single VC would take the A getting 33%. Two VCs would team up for the B round with one new VC joining the syndicate so each takes 15% and for C rounds a third VC joins and they each get 10%. All these numbers have changed and basically gotten smaller and in recent times it’s common to see one major VC take the lead and a number of other VCs be willing to take small percentages, which is more and more common with the proliferation of micro-VCs. I often ask the other VCs with small percentages what level of due diligence they conducted and how committed are they to supporting this company if this is not a “major fund investment” and their percentage low.
So why do these VCs insist on these minimum ownership targets?
There are two primary reasons for this and a number of lesser reasons. One is that some VCs expect every investment they make to have the potential to return the whole fund. Accel is famous for saying this in every first time meeting with an entrepreneur. If their latest VC fund is $450m and they also just raised a $1.5bn growth fund I suppose the first time they invest in a startup they need to buy enough of the company so that at the time of exit their exit consideration will return at least $450m. Keep in mind Accel will only own a minority percentage of that company at the time of exit. If the company they are investing in has a pre-money valuation of $15m to $50m the percentage they buy needs to have the potential to return $450m at exit. They play with possible numbers of what the company could be sold for or IPO at and then they look at the ownership percentage they would need to return that entire fund. When another VC comes along and suggests they each invest an equal amount taking 50% of the round, that will lower the percentage they can get and influence their decision to walk away or give a take it or leave it offer to the startup to let them take a full 20% or else they will not invest at all. From time to time this even breeds some unnatural behavior ☺
I am not picking on Accel here and have never had a bad experience with them (OK, not for over 10 years), but just trying to help everyone understand why this happens. We often see large investors come in looking at our portfolio companies and say they don’t really care what the valuation is, but they just want to make sure they get at least 20% by investing in the next financing round.
If you look at the number of exits or percentage of venture exits big enough to return the entire fund at any normal percentage ownership level and your latest fund is $500m, $700m+ or $1bn+ I just don’t think the statistical probability is on your side to consistently return the entire fund with a single portfolio exit decade after decade. I think this relies too much on luck.
Other VCs will say that each investment needs to provide enough ownership such that at exit this could return 50% or 25% of the fund. If you operate this way and invest in 20 to 30 companies out of a single portfolio and are following the 25% rule then you only need 4 good hits to return the entire fund and then your LPs should be happy, you the GP should be in carry and your portfolio companies not put under unnatural pressure to defy gravity and be in the top 1% of all exits.
The other reason for minimum percentages is board seats. Every VC will tell you how many board seats she can be on before becoming ineffective. I’ve heard some VCs tell me they can be on six boards and others tell me they can be on 10 and still be effective. The top partner at a large Sand Hill Road VC once confessed to me that he was on 38 boards and trying to get off of 28 of those. Basically each time they invest the startup and existing syndicate insist on him and he joins, but can not be effective.
If you are on 10 boards and assume conservatively that you will have between 4 to 10 board meetings per company per year then you are really looking at 40 to 100 actual board meetings per annum. Some require an airplane trip to get to. In theory the VC should prepare for each meeting, be present at the meeting in both mind and body, and execute on action items and follow ups following the meeting. VCs are also busy finding new investments, conducting DD, doing lots of hustling for their portfolio companies where they are on the board and other portfolio companies where they are not, raising new funds, etc.
If you can only join one new board should you join the one where you own 1.5% or 20%?
This is why most VCs threaten to walk away from a great deal if they can’t achieve their target ownership percentage.
At Rubicon we are completely different. We understand ownership percentages, but often invest in-between rounds for the company with a small check and put our network to work supporting the company without taking a board seat or being concerned with the percentage ownership. We believe getting into the very best deals we can is good for our LPs and the startups. If we add enough value to the startup we expect to be able to put more money into the next round and balance into the sharp elbows to get some ownership with our capital and good manners! Entrepreneurship and venture capital is a long term commitment and we are playing the long game.