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June 20, 2005
Know Your VC’s Magic Number
All VC firms are all different. As I wrote about in a previous post, every one has a different process for evaluating a potential new deal. In addition, venture firms all have a different magic number for how much capital they would like to deploy into each of their portfolio companies.
At the heart of the issue is that different VCs are managing different sized funds – so the appetite for how much capital they would like to invest in a company over its lifetime varies accordingly. Because venture firms’ partner time is limited by how many relationships with portfolio companies s/he can manage, VCs only have a set amount of bandwidth to cover a certain number of deals. As a result, the amount of per-partner capital under management is directly proportional to the amount that needs to be deployed per investment.
The above statement may seem self-evident in retrospect, but I am not surprised that many of the (usually first-time) entrepreneurs that we meet with who don’t ask about our fund and typical investment size (until we bring it up) or don’t appear to fully understand the ramifications of it. In conjunction with finding a VC that is the right fit, part of the difficulty on the entrepreneurs’ end is trying to wrap their head around how much capital s/he will need to fully fund the “vision” over the lifetime of the company. Raising money from a small fund (or a syndicate of small funds) may leave the entrepreneur back at square one in looking for additional growth capital when his/her current investors have max’ed out the level of investment that they are comfortable with. This situation is not terribly bad, as smaller fund investors do provide a valuable feeder system into the larger funds. On the other side of the coin, however, getting into bed with large-fund investors with a need to deploy significant capital too soon may create a situation where there is undue pressure for the entrepreneur to spend and expand at a rate which may not be healthy for the company (and, in turn, reduce the amount of founders’ equity in subsequent rounds).
Like in many other aspects in starting a company, it is the job of the entrepreneur to manage this issue with balance. Choosing thoughtful syndicate of investors is one way to further address these concerns. In determining if a venture firm is a good fit for an entrepreneur (and vis versa), every first meeting should include a brief discussion about fund size, typical initial investment size, and the magic number of how much the VC would ideally like to deploy over the life of a company.
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