What You Should Know

About Early-Stage Venture Capital

Jyri Engeström @jyri

yes.vc

Yo starting a new VC fund

General Partner (GP)

of a venture capital firm

a.k.a. the “VC”

$50M

Fund

x 3 in 5-10 years…

$40M

Investments

Fees (10y)

50%

Initial Checks

50%

Follow-Ons

​

$20M

Actual allocation to new investments

20 x

$1M

Deployed into 20 companies over 3 year investing period

​

Each investment is $1M, on average

$1M

10%

$10M

Investment

Ownership

Valuation

at

for

Repeat 20 times to create a portfolio.

A common early-stage Valley VC investment in 2020:

Wait 4.5 years, on average...

10%

$50M

$5M

Ownership

Exit Value

Return

=

of

$50 million scenario

$5M = 5x return on investment. Great news!

...Or is it?

$50M

x 3 =

$145M remaining

$5M return

$5M is only 3% of the expected return of the fund

YES VC

20 companies

Return multiplier

Most probably, almost all of the VC’s returns will come from one company

5x exit

Congrats, but… this VC just missed one of their 20 shots on goal.

x

So. To qualify for VC investment,

your company needs a credible path to becoming their sole fund returner.

$1M investment

=>

$150M return

needed to 3x the fund

This VC needs to see the path to a 150x return, every new company they invest in.

$50M fund

At 10% ownership, it translates to a $1.5 billion exit.

$1.5B

Exit value

$150M return

10%

Wait... we didn’t account for dilution.

10%

=>

5%

Companies commonly raise A, B, C, D… rounds before exit.

Early-stage ownership stakes dwindle down further with each round.

(If it can, the VC will deploy its reserves to slow down its dilution).

To account for 50% dilution, the needed exit value doubles to $3 billion.

​

$3B

Exit value

$150M return

5%

Before raising $1M from a $50M venture fund,

look in the mirror and ask:

Do I see myself building a $3B business?

(It’s what you’re signing up for)

If the answer is you are probably better off not raising VC.

But it doesn’t necessarily mean you should not raise any financing.

You can tap angels, family offices, impact & non-VC funds, corporates, loans and grants.

Or, new “challenger” venture funds (look up Indie VC) with nontraditional models.

Uh, no...

The VC decision tree

(Often more like a pinball game)

​

At time of intro, these matter:

• Who else is investing?
• Who makes the intro?
• Google results about founder

​

Mention these in your first email:

• How fast is it growing
• How big will it get
• How much have you raised so far

​

Ultimately it boils down to:

• Do you obviously have the chops to take it to a massive exit?
• Does the VC love the product?
• Deal terms, valuation, and expected amount of downstream financing

The superior capital source is not a venture fund. It’s your customer base.

​

Mailchimp is worth $4B+ and funded 100% with customer revenue.

​

Start on that path and the VCs will come calling at your door.

​

PRO TIP

What “perfect” growth looks like to an early-stage VC

​

1. Customers generating revenue from day one
2. 20% MoM growth
3. Breakeven 2-3 years in
4. Less than $5M financing needed to breakeven
5. Path to 80% margin
6. 15x revenue multiplier achievable for exit valuation
7. Estimated year 4 exit value $1.2 billion

1

2

3

4

5

6

7

When you grow like this, you have ample access to venture capital,�but need it relatively little.

It is why many VCs are so weary of founders who reach out to pitch.

A founder who has to woo investors is probably not on this growth path.

Strong founders raise VC like elite players play Super Mario Bros.

​

They use Warp Pipes to skip levels.

Thanks @shanesnow

for the warp pipe analogy!

Warp Pipe through the VC process

​

1. Intro from another founder or investor—often initiated by the VC
2. Meeting immediately—VC often comes to founder
3. Term sheet “before the Uber arrives to take the founder to their next meeting”

What “perfect” capitalization looks like to an early-stage VC

​

• $1M Angel/Pre-Seed at the very start
• $3M Seed in year one or two
• Skip Series A (Warp Pipe )
• Growth round in year 3 or 4
• IPO in year 5 or 6

2024

2025

=> “Home run” for the founder and the investors

3

5

4

1

2

Burn breakdown (Valley salaries)

​

• 5 person core team in year 1
• 19 people in year 2, then grow 10% MoM
• Allocate 20% to customer acquisition
• 15% to everything else

3

4

1

2

Other functions like B2B sales come into play in a serious way after growth round.

Equity allocation example

1. One founder
2. One employee in the beginning
3. 10% pool, refresh at financings
4. $950k Pre-Seed round at $7M (post money) valuation
5. $3M Seed round at $30M (post money) valuation
6. Angels & pre-seed VC not participating in later rounds
7. Value calculated on 15x revenue multiplier

3

7

6

1

2

4

5

Tune to fit your circumstances.