How Does Seed Stage Fund Math Work?

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A guest post by our Managing Partner, Henri Pierre-Jacques

Now that I invest in funds, I’ve seen dozens of emerging manager decks and the fund model is one of the biggest decisions and misses that I see. VC is as much math as gut. Let’s get into it

1/ First you must decide which camp you are in
1) Concentrated portco (sub 20) w/ significant ownership (10%+)
2) Diverse portco (20-45) w/ decent ownership (5-10%)
3) Large portco (45+) w/ little ownership (sub 5%)

*There are exceptions to each category depending on fund size

2/ The majority of Fund 1 and 2s I see are $10-75M so this applies for them largely. The average Seed fund has 28 investments according to Sapphire and is by far where I see the most funds so let’s focus on camp 2 of diverse portfolio

3/ Most funds I see are targeting 25-35 companies for 5-10% ownership. The ownership target largely depends on fund size which determines check size. What I’ve seen by fund size:
$10-25M-> 5-7%
$25-50M->6-8%
$50-75M-> 8-10%

*Some VCs don’t have ownership targets, but the majority I have invested in do. But how do you determine it??

4/ The calculations followed by an example
Fund Size – Mgmt fees – LP expenses = Investable Capital
Investable Capital – Follow on Capital = Initial Capital
Initial Capital / Portcos = Initial Check
Initial Check / Post Money Valuation = Ownership target

5/ Example with $25M fund
$25M – $5M mgmt fees (2% x 10yrs) – $0.5M LP expenses ($50k x 10yrs) = $19.5M Investable Capital
$19.5M – $5.5M Follow on (23% is on low end) = $14M Initial Capital
$14M / 28 portcos (average) = $500k Initial Check
$500k / $10M valuation = 5% ownership

Managers don’t realize they will only invest 40-60% of the fund into initial checks and founders think funds can write larger checks.

6/ There are check sizes that founders can estimate based on fund sizes
$10-25M-> $250-500k
$25-50M-> $500-1M
$50-75M-> $750k-1.5M

A generally rule of thumb is a fund invest 1-3% of fund size as an initial check.

7/ There are a few nuances managers miss in the model that make a big difference in returns:
1) LP fees such as legal, taxes, fundraising, fund admin, etc. typically account for 2.5%+ and are separate from Mgmt fees
2) Recycling early exits (18-36 months) into new companies for more shots on goal to get outliers
3) Investing years 4-10 mgmt fees, often the biggest miss

8/ Most funds have investment periods of 2.5-3yrs, which is when they invest in new companies. Investing the outer year Mgmt fees has huge implications, an example:
$25M Fund – $5M Mgmt fees (10yrs) = $20M Invested
$25M Fund – $1.5M Mgmt fees (3yrs) = $23.5M Invested

That’s $2.5M more to invest or 10% of the fund. That is 5 more companies or $2.5M more in your winners

9/ There unfortunately isn’t much written on these nuances and I had to learn by doing and many conversations with other GPs and LPs. New GPs should have their model down and adjust throughout investing, it shouldn’t be static. Founders that understand VC math have advantages.

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