Fundamentals of Venture Capital

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Fundamentals of Venture Capital May 2020
Manish Singhal
Founding Partner, pi Ventures @manish_saarthi

2
https://dilbert.com/search_results?terms=Venture+Capitalist

Agenda
VC as a business
Power Law
What does it take to run a fund
Structure
Design & Strategy
Execution

Statutory Warning!
This presentation may be injurious to your VC ambitions!!

What is the core business of Venture Capital?

Raise Money
Invest Money
Return Money

piVentures2020AllRightsReserved
Do VCs really make Money?
https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the...

What is a good return to aim for?

IRRs
http://www.industryventures.com/the-venture-capital-risk-and-return-matrix/

Good Return?
Most LPs would expect around 12% p.a. return as other
instruments would probably be lower but safer
Assuming...

Flat Model Capital Call Model Early Returns
1 Jan 2020 -100 -20 -10
1 Jan 2021 -20 -20
1 Jan 2022 -20 -20
1 Jan 2023 -20 -...

VC IRRs (less than 250M USD)
Source: PitchBook

Fund Return Multiples (TVPI)
Source: PitchBook

Overall, if you make 3x-5x, you are in good
company!

Road to 3x

Scenario
Fund Size: 100M USD
10 Investments. Flat allocation - 10M per investment
Desired Return is 3x. 300M USD exit v...

Scenario 1
https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the-truth-about-vcs/
They all do “average” and exi...

https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the-truth-about-vcs/
Half do average like before, and half do...

https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the-truth-about-vcs/
Majority do “average;” we’ll throw in
an...

https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the-truth-about-vcs/
We need one big fat unicorn exit!
We wou...

https://techcrunch.com/2017/06/01/the-meeting-that-showed-me-the-truth-about-vcs/
The Realistic Scenario
Five startups fai...

Fund Exit Values
(Assuming 3x Returns)
Equity Ownership, Total Exit Value (B USD)
Fund Size
(M USD) 5% 10% 15% 20% 25%
20 ...

Fund Exit Values
(Assuming 3x Returns)
Equity Ownership, Total Exit Value (B USD)
Fund Size
(M USD) 5% 10% 15% 20% 25%
20 ...

Power of Power Law!

Startups Success Odds
https://www.sethlevine.com/archives/2018/04/whats-the-optimal-portfolio-strategy-for-a-venture-fund....

Few Deals make the Returns!
https://www.ben-evans.com/benedictevans/2016/4/28/winning-and-losing
For funds with an overall...

Few Funds make up the return for LPs

Power Power Law rules the VC industry!
https://visible.vc/blog/understanding-the-power-law-curve-of-vc/
https://blog.ourcr...

Return Persistence
Top Quartile funds tend to remain there
https://blogs.cfainstitute.org/investor/2020/02/17/venture-capi...

Do you still want to become a VC?

VC - Mirages
Make a lot of money!
I can “help” entrepreneurs
I don’t like operations
All I have to do it listen to some...

“Long Term” reasons to become a VC
True passion for being part of creating the future
Working with the best of the entr...

What does it take to run a Fund

piVentures2020AllRightsReserved
Typical Fund Structure
Limited Partner (LPs)
Startups
Fund
Management Co
General Partners ...

piVentures2020AllRightsReserved
Other Entities
Sponsor
Jurisdiction based rules
For AIF funds (India), every fund needs ...

Typical Time Lines
Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10Y0
Fund Raising
Fund Raising
Commitment
Period
Follow Ons
3-5 Years
2 y...

VC Treadmill
Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10Y0
Fund Raising
Fund Raising
Commitment
Period
Follow Ons
4 Years
2 years pos...

Investment Team in a “Startup” Fund
Analyst / Associates / VPs Principal Managing Director Partner General Partner
Deal So...

Non-Investment Roles
Finance / Compliances
Dedicated Product Roles
Dedicated Business Roles
Marketing Roles
Admin Staﬀ

Carry Allocation
Equivalent of ESOP Allocations for Startups
General practise is to keep this for Investment Team
(Above...

Prevalent Numbers
https://vcpreneur.com/vc-funds-101-understanding-venture-fund-structures-team-compensation-fund-metrics-...

Fund Strategy
Thesis
Stage
Capital Allocation
Portfolio Construction
Target Ownership
Investment Committee

Thesis
Thesis design is most critical in these times
Narrow vs Broad
Specialized vs Generalist
Gives focus and position...

Stage Choice
0 1 2 3 4 5 6 7 8 9
Valuation
Seed
Round
Angel
Round
Series A
Series B
Series C
Product Market Fit Business M...

Stage Choice
0 1 2 3 4 5 6 7 8 9
Valuation
Seed
Round
Angel
Round
Series A
Series B
Series C
Product Market Fit Business M...

Stage Choice
0 1 2 3 4 5 6 7 8 9
Valuation
Seed
Round
Angel
Round
Series A
Series B
Series C
Product Market Fit Business M...

Stage Choice
0 1 2 3 4 5 6 7 8 9
Valuation
Seed
Round
Angel
Round
Series A
Series B
Series C
Product Market Fit Business M...

Portfolio Construction
What is the optimal number of companies?
Balance between too few shots and spreading too thin
Case...

Portfolio Construction
X number of companies
Half of them raise only ﬁrst cheque (1M)
Half of Half raise one more 1m (2M...

Portfolio Construction - Key Considerations
Min 10-12 investments
Balance between going deep vs spreading thin
Number of...

Capital Allocation
20%
40%
60%
80%
100%
20% 40% 60% 80% 100%
First Cheques
Follow Ons
Spread too thin
You have to be a
re...

Follow On Funding Data
https://www.cbinsights.com/research/venture-capital-funnel-2/

FC: FO Ratios for an early stage VC
Round Number of SUs
Round Size
(M USD)
Prorata Amount
(20% ownership)
Seed Investor
In...

Capital Allocation
FC - FO
40-60
FC - FO
50-50
FC - FO
60-40
Ideal
Forces discipline on
ﬁnding right deals at the
ri...

Target Ownership
Equity Ownership, Total Exit Value (B USD)
Fund Size
(M USD) 5% 10% 15% 20% 25%
20 1.20 0.60 0.40 0.30 0....

Napkin Method to understand ownership needed for
3x return
Investment
30M USD
Total Exit Value
1B USD

Napkin Method to understand ownership needed for
3x return
Investment
30M USD
Total Exit Value
1B USD
Exit Needed - 100M
...

Napkin Method to understand ownership needed for
3x return
Investment
30M USD
Total Exit Value
1B USD
Exit Needed - 100M
...

Entry Ownership for a typical Early Stage Fund
0 1 2 3 4 5 6 7 8 9
Valuation
Seed
Round
Angel
Round
Series A
Series B
Seri...

Path to Ownership
Stage Round Size
Post Money
Valuation
Pro-Rata
Amount
Fund
Participation Ownership
Seed 1 4 1 25%
Series...

Path to Ownership
Go big early Go cautious early
Good ownership
Rights are easier to get
with bigger investment
early-o...

Investment Committee
Typically comprises of Partners & External members
Key Decisions
Internal vs External
Consensus vs...

Running a Fund
Raising Money
Building a team and a great culture
Getting access to the best deals
Portfolio Work
Makin...

Raising Money
Most diﬃcult process in the lifecycle
10x more diﬃcult than raising money as an entrepreneur
First time fu...

Building a Team & Culture
Funds typically have a small teams
Structure
Roles
Independent thinking yet have common goal...

Portfolio Work
Good probability of a break out
Great team. Solid PMF. Good
Capitalisation
10-15%
Struggling
Team Issues...

Portfolio Work
Good probability of a break out
Great team. Solid PMF. Good
Capitalisation
10-15%
Struggling
Team Issues...

Making Decisions
You are constantly making decisions with less information
Intellectual Honesty
Emotional Awareness
Kno...

What does a PMF for a VC fund look like?
Submit your reﬂections on a slide or two

Thank You!
*Thanks to Prof Shivaram from IIT Mumbai for the phrase
J AI HIND*

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