Charles Hudson explains how founders should build lists of prospective investors by understanding venture capital firms' business models. He uses numeric examples (e.g., a $100M seed fund targeting 3x net, typical ownership ~10%; a $1B multi-stage fund targeting similar returns and owning ~20%) to show why fund size and required exit scale shape which firms are appropriate partners.
Chapters
We spend a lot of time helping founders put together high quality lists of VC funds to target when it's time to go out and raise a new round of financing. And to put it simply, there are many, many great, highly regarded, well known, successful, helpful venture capital firms that could play an important role in your journey at some point. But one thing I want to communicate to everyone is that it's really important to understand the business model of the venture firms that you're pitching, because some funds might be better than others for you given where you are in your journey. So I do think it's important to just understand the basic structure of most venture funds. Let's take your typical $100 million seed fund. They probably promised their investors that they would give them three times their money back net, which means that $100 million needs to turn into 400 million or $300 million net of the original investment. Let's say they own on average 10% of the companies. That's what they're buying at the seed round. And many of you have raised seed rounds? No, that's a common ask. That means to return 400 million to their investors, that firm needs to own 10% of companies that in the aggregate end up being worth $4 billion when they exit. This is why even relatively small seed funds care about two things. The amount of your company that they can buy in a given round and the size of exit that you can ultimately produce for them. Now scale that up to $1 billion fund that may be committed to a three times net return and can buy 20%. So let's do some more math here. That billion dollars has got to turn into $3 billion of proceeds so that you can return the billion dollars that you originally raised plus 2 times their money. So that's 2x net 3 times gross. Assuming you own 20% of a company, that really big multi stage, multi billion dollar venture firm needs 10, 15, $20 billion of aggregate exits in order to get back to the returns number that they promised their investors. What does that mean? It means those firms are fundamentally looking for companies where the exit potential is a multi billion dollar public company. That's it. That's kind of all that really moves the needle for their model. And they're going to judge all the opportunities that they see through the lens of can this investment ultimately help us meet our returns hurdle? So this is just something to consider when you're building your investment list. If you're raising a seed round and you've got tons of really great, awesome multi stage, 500 million to a billion dollar Series A and beyond funds on that list. Just remember the math that they're trying to solve for and just be critical and think to yourself, can my company really help them advance and make the numbers that they need to make their fund model work?
