Venture Math 101

My good friend and professional instigator David Crow sparked some reactions last week with this 100% on the money tweet.

Mark Evans chimed in to dispel the myth that there is not enough VC$ in Canada. He then followed up summarizing reactions from a number of Canadian VCs including me.

Yes, it would always be great from an entrepreneur’s perspective for more capital to be available. Lets set aside whether that would be good for the VC industry for the moment. I have a theory about why founders perceive there to be a lack of capital:

The reason most founders think there is not enough capital is that they get rejected when they go looking for it. And one of the main reasons they get rejected is that their opportunity does not fit what VCs are looking for.

I’m not saying these people have bad businesses. They just don’t fit the narrow definition of what a VC needs in order to generate returns.

What I’d like to do in this post is give a high level overview of how VC fund math works since this in my view is a primary driver of VC behaviour and is the reason why most founders get rejected.

VC Math 101

Let’s take a typical $100M VC fund. That’s quite small, but is a nice round number for this exercise. The basic structure of a fund is as follows:

– Limited Partners (LPs) commit to invest $100M over a number of years

– The VCs (General Partners or GPs) call that capital over time as they need it in order to pay expenses and make investments

– The normal deal is 2% of the $100M per year in expenses and 20% of any profits (known as ‘carry’ or ‘carried interest’) after the entire $ 100M has been returned to LPs

– LPs sign up for a 10 year commitment. Meaning they need to keep funding (or they lose any capital contributed already) and they can’t sell their position since VCs invest in privately held companies.

– Because VC funds are illiquid and high risk they are expected to deliver higher returns to LPs than they could get from other, more liquid investments.

The typical target is to triple the size of a fund in 10 years. That sounds like a lot but it equates to a 20% annual return. Definitely higher than public stock markets (most of the time). That means that a $100M fund has to generate $ 300M in gross proceeds from the sale or IPO of its investments.

Consider the fact that a typical VC fund owns a minority stake in its portfolio companies. That means it needs to generate a huge amount of exit value in order to hit its target returns.

Here is a simple illustration of this math: ย If a fund owns on average 15% of each company it invests in, it needs to generate $ 2 billion in exit proceeds in order to pull out $ 300M for itself.

This is friggin’ hard to do. Let’s approach this from a Canadian VC context. Last year was a great year for exits in Canada:

Radian 6: $ 326M

Q1 Labs: $ 300M (estimate)

MKS: $ 292M

Adenyo: $ 100M

So, if I was running a $ 100M Canadian VC fund, I would have to had to be in all of these companies early enough to get to and keep 15% and would still be only 1/2 way towards what I need in order to deliver my target returns.

So why does this matter? Simply because this is why you’re getting rejected all the time. Every time you meet a VC he or she is assessing the probability that your idea could turn into something that would generate a huge outcome and that you have the potential to execute and build a big company.

Judged against this bar it’s easy to see why most opportunities get rejected. To be clear, the vast majority of outcomes are sub $ 100M. But VC is a business of outliers, not averages. If a VC doesn’t see potential for an outlier they will pass most of the time.

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  • Matthew Coco

    This all makes sense to me. It seems really strange that something as straightforward as this is hard to understand by a startup CEO. If someone is not going to get what they want from you then they’re not going to play! And that goes for your startup customers as well. Thanks for the post Mark!

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  • Cloud Wonderer

    Now I know why not to turn to VCs :). Building your own company without investment from VC provides more freedom.

  • What’s wrong about this is that there is a lot more diversity of capital for instance in the states then there is in Canada and the funding ranges differ. So if you’re building a startup like mine which will require very large amounts of capital over time then there is difficulty. Are there lots of bad ideas yes but the sectoral experience isn’t necessarily there and the volume of capital for some companies who either need the capital over time or want to partner with a VC firm for the long haul is not option like it is in California. Also because Canada is not as innovative as some other countries for the time being it is often my conclusion that there is a lack of imagination about ideas or for that matter betting on the wildcards which can turn out to be big wins for the innovative reason as well as the other reasons stated above.

    • I won’t comment on the last part. Sounds like it is reinforcing some stereotypes. But for sure, if you are in a capital intensive business then you will have an even tougher time raising $ in Canada.

      • I’m not saying that to come down on anyone . but it’s obvious when you’re more capital limited it means you you’re less willing to take fewer risks and it also means that some entrepreneurs may be less likely to swing for the fences because they may thing that they can’t get the capital they need. You can make the argument that for an entrenepeur’s entrepreneur that none of that matters and they will find away but I’m arguing for fallibility instead.

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  • Ross McDonald

    Interesting post Mark. Perhaps a dovetail question is how Canada, with its vast federal grant funding programs such as SR&ED and NRC-IRAP, can stimulate the creation of a larger number of startups that are suitable for VC funding – irrespective of whether the VC is Canadian or otherwise?

  • David, thanks for the realistic view of the VC perspective. I completely understand it. However I wonder why so many Canadian startups are rejected at home and go south for money. The money is here, yes but local angels (seem) to prefer to invest in real estate, biotech, green tech, agri business and oil from what I see. However my perspective is that the small angels are not there as individuals but as angel funds. In Silicon Valley if you pitch to 100 or more angels and your model is solid and you are showing progress, etc. you may have a small % shot at investment. I suspect a large % of the young Stanford / MIT crowd are playing the alumni connection system but recent studies ( at Y Combinator) are showing the best chances in tech startups come from those over 40 and increase with age. They cite several factors but subject matter expertise and interpersonal skills play huge factors.

    When it comes to Canadian investors I fear most are afraid to step out on their own and tend go with the herd of the managed fund. Politics seems to play a big part too and Canadian investors seem to be enamoured with degrees and research grants. Sure, a lot of cool biotech and nano tech stuff is coming out of the universities, but there is a lot of credentialism in Canada that you don’t see in the US. Funds are managed by pros and they are not sticking their professional necks out for a startup on a hunch, whereas a private angel might if they know the space and like the team. There lies the difference. I have gotten over the hard feelings about being turned down by Canadian investors. It is a sad hard truth among most if not all the tech startup folks I have talked to.

    We are just making steady gains on the market and the vision and I hope that a Canadian investor will come on board, first as a mentor ( there are a lot of smart people out there) and then supporting it. However at this point I do not care who invests, and I will take what comes when it comes and keep bootstrapping an pivoting until it makes it. However the longer I stay alive and improve the product and get sales the less and less I need early angels so the deal becomes more like a bank loan or a VC deal and the big win is not there.

    I have two standout memories from Angel discussions. Not all were bad and many were supportive and helpful. But I have heard people stand up in pitches and tell me the market gorillas will kill me (tell that to Google and Facebook), that the first thing they do when they invest is boot the founders and that they want to see customers and revenue first. The latter I don’t mind so much but it is a touch slog getting there.

    It seems to boil down to the team, their track record and credentials and more so in Canada. Also it takes a lot of pitches and persistence to find the right combination.

    Bottom line is you need to be prepared to boot strap your startup to revenue.

    • Your comments have captured every stereotype about Canadian investors. There may be some cases where these points are true (same in any country) but there are just so many counter-examples.

    • I’m sorry I missed the thesis in the argument. Canadian companies need to go south to raise institutional money?

      Raising money is hard. Regardless of that is in Canada or in the US. The secret is to build successful companies. Different companies need to demonstrate success differently at different stages of development. I have actively suggested that Canadian companies get on planes to Boston, NYC, SF, Palo Alto and other places. They should use AngelList, and talk to as many investors and customers as possible. But as you’ll see from opinions like @bfeld:twitter, that

      “Donโ€™t try to get investors to do unnatural acts: Assuming you are looking for capital, focus your energy on two categories: (1) local investors โ€“ either angel or VCs and (2) VCs that are interested in the specific business you are creating.” – @bfeld:twitter

      Having a local lead is one way, but not the only way, to get VCs to avoid unnatural acts.

      Additionally there might be more capital available through Friends, Family and Fools in other geographies. My argument is that in Boston or SIlicon Valley, many employees have additional disposable income and a relationship with someone that was a founder or an early investor in a company that has had an exit. This makes tech angel investments more familiar and appealing. But I don’t have data to back this up.

      Given that YCombinator doesn’t do studies, they make investments, made up data without sources can’t be trusted as anything other than misinformation or hearsay. The specific data you source is from the Kaufmann Institute not YCombinator. Additional coverage at

      I think Canadian entrepreneurs should aim to get as many rejections as possible early. Whether they are at home or abroad. They should also ask for meaningful feedback about the metrics and traction numbers that each investor would like to see to move the business forward. And upon returning to their desks/companies start executing to knock down those metrics. Maybe rather than treating “growth capital” as an entitled right, we should realize that we have to build businesses that earn it. Go out and build a crazy successful business with real customers that is growing like crazy.

      And I’m a fake VC (even that gives me too much credit in the VC world, I’m an entrepreneur that is employed by a VC fund). For real VCs follow @derekjsmyth:twitter @howardgwin:twitter @rchabra:disqus @chrisarsenault:disqus and others.

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  • Michael Carpentier

    Great points!

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  • Canadian VCs funding Canadian startups is great for both sides of the table.

    So, I see three ways to deal with this problem.

    1. Shrug our shoulders.
    2. Figure out how to make more VC-fundable companies.
    3. Change the VC math for Canada.

    Everyone who wants to choose #1 can stop reading now.

    Setting that aside, how could we do the others? For the second, I see a few ways to get better startups here:

    * Stimulate the “pre-startup” environment to generate more home-grown startups
    * Bring startups from elsewhere to Canada.

    What’s the “pre-startup” environment? Developers and entrepreneurs starting businesses. Maybe small businesses — but getting used to making money with technology. What works? What doesn’t? One thesis is that a rich soup of non-scalable technology businesses will spontaneously generate scalable ones. I’m not sure if that’s the case, but it’s probably a thesis worth testing.

    I think accelerators like GrowLabs and FounderFuel are doing an OK job with bringing startups to Canada, although I still maintain that specialization would make them stand out more and attract more world-class startups. I also think the startup visa program can help here, too.

    For changing the VC math, I think there are a couple of ways to make it work. One is getting more government money. Although there are probably lots of ways that government can help, I’m not sure it’s our biggest problem.

    Another is to structure funds such that their investors benefit from the situation they’re in right now — Canada, 2013 — rather than a theoretical market that doesn’t exist.

    Success in business come from finding opportunities that others are missing. Who’s the fund who will find the way to make money from the world of Canada 2013?

    I think an ideal situation would be a style of fund that stimulates “pre-startup” activity and still makes money. That’d solve two problems at once — a nice synergy.

    • Thanks for your comments Evan.

      It is possible for Canadian VCs to make money. It requires two things:

      1.) We fund our companies not just in the early stages but later (rather than forcing our companies to raise in the US for later rounds); and

      2.) Have our biggest tech successes go public in Canada.

      These 2 points go together. When I entered this industry in the 90s there was a robust tech IPO market. It turned out to be a bubble. But unlike Nasdaq it didn’t come back up here. We need some big giants here that gobble up other startups, build an ecosystem around them, and spawn off alumni that have seen real scale and are ready to do another startup.

      On the 3rd point, Canada has just paved the way committing to pass a startup VISA act.

      • Interesting response! I think there’s probably something telling that most of the solutions I see are at the bottom end of the spectrum (more small tech companies) and the ones you see are at the top (more later-stage funding, big exits, and a healthier IPO market). We probably have to get both sides of the spectrum more robust.

        • Well, we invest much closer to where you are, but it’s just a fact that the biggest influence on fund return is having a home run (big) outcome. To be clear though: you don’t get big outcomes with a robust early stage ecosystem. I think there’s a lot of good early stage activity though. We are just missing the late stage big stuff

  • Mark, you make it sound like a Venture Capital is a really bad investment. Now I’m curious to know how LPs feel after you assert that a 20% return on their very risky investment is virtually impossible (i.e. It won’t even happen with 10 straight years like 2012).

    Is that really the case or have I misunderstood?

    • It’s very difficult to generate great returns, though not impossible. It takes an extreme outlier. Foundry Group raised a new fund quickly because Zynga was in their previous one. If you have a rocket ship, you can get premium returns.

      • So if you become a billionaire. Which investment would you choose, VC or NHL franchise ๐Ÿ˜‰

        • Good question. Both probably. Though I’d prefer to own an F1 team…

        • A good F1 team.

    • But to be clear: most funds don’t generate the returns that their LPs are looking for

    • Gregg, I think it really depends on the fund size. Also, Mark is right that all the exits in 2012 don’t equal a successful fund, but remember that over a fund life there will be multiple years (5-7) of exits experienced.

      Mark’s great venture math also shows that it is tough to be a $100M+ fund in Canada. My belief has always been that you have to be a cross-border fund (as iNovia is) in order to succeed in Canada as a $100M+ fund. While this can be well supported with data of Canadian exits (or lack thereof) over the last decade I have to admit that I am very bullish on where things are going in Canada and that there will be room for a few successful $100M+ focusing solely on Canada in the coming years.

      • Hey Kevin, good comments. While the exits I used happen to be in th same year, those are pretty high exits by Canadian standards. My point is mainly that regardless of the timing of these outcomes it takes some great outcomes to deliver a successful fund.

        • You’re absolutely right. Lets hope we have a few more big ones in the future. The availability of more capital will hopefully allow Canadian companies to go bigger and build an anchor pillar in the eco-system rather than having to take an early exit as we see so often.

    • I think a bigger question is, if venture capital isn’t going to put more money into more startups in Canada, is it really the right vehicle for government stimulus of the tech sector?

      I blogged about the question here:

      • Great post Evan. Added some comments.

      • That’s a worthwhile questions to ask. As an industry, we haven’t done our part to help policymakers make informed decisions. I’ll expand on that in a comment on your post.

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  • Jimmy John

    Maybe VC’s should stop spending so much on office space, employee salaries, and take a lesson from the startups by bootstrapping more. I’m sure if they were to do this they could invest in more companies and improve their chances of making more money.

  • Vince the CFO

    Mark – the math is undeniable. As you’ve blogged multiple times, betting on hitting it out of the park isn’t greed, it’s survival for a fund! Make your business case rock or go home!

  • You are right on the nose Mark! You should stay into VC… Unless you figured out the Venture Match… I think it’s great to put things back into perspective. We go back to our Portfolio Venture Match analysis 4 times per year! Not that our fees our much lower then what you mention above though ๐Ÿ™‚ to our returns advantage. Yes VC is a business of outliers, not averages. And I really like your line: ” The reason most founders think there is not enough capital is that they get rejected when they go looking for it. And one of the main reasons they get rejected is that their opportunity does not fit what VCs are looking for.” And I do think it’s an awesome time to build a BIG Tech Business.

    • What is this Portfolio Venture Match analysis ?

      • It our internal per Fund analysis base on specific portfolio company performance to date, revised expectations, money invested, additional capital expected required to exit, our fund likely additional participation (reserves), ownership, expected future dilution, exit potential evaluation and tied into a timeline. Its a bottom-up approach to your Venture Math, in order to assess the realistic scenarios of achieving that Fund 3x over its lifetime. It helps identify the out-performers and those we need to double up on, or not (those we need to cut loose sooner). Its a picture in time based on progress and where things are heading.

  • Jevon

    You know a lot. You should quit this operating bullshit and go in to VC. I hear it is fun.

    • Want to start a fund together?

      • In. JMR Capital?

        • We probably need to include Crow as well, now that he’s got one foot in the darkside. JMRC Capital.

        • JMRC Venture Partners

        • you mean JMRD! has a better ring to it anyway….

        • JMR Blackbird Ventures

        • How much to pitch in for an LP? JMR-TCH.

      • Totally. One thing: I am pioneering the 80/20 model of VC. 80% in fees 20% working hours.

        • We already have the working hours. None of us work. Roger’s been teaching me how to play competitive tennis

        • what? I havent played tennis in over a year!

        • I love the 80/20 model.

  • Excellent post, Mark. I am amazed at how many people are still saying there is a shortage of VC money in Canada. For the reasons you outline in your article, I still believe we have move VC capital than VC suitable investment opportunities.

  • Bill Bryant

    Mark , thank you for this post ! It is one of the clearest, most succinct summaries of the venture capital model that I’ve seen. Venture capital has a business model too ! and if as you say a startup doesn’t map to that model, then they aren’t likely to be successful in their capital raising efforts. Sine qua non.

    • Thanks Bill. Most companies that approach VCs just dont have that fit

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  • I don’t think people take the time to do and re-do their numbers. Entrepreneurs should know key numbers like operating margin, break even sales, burn rate, etc. in their sleep, but most don’t. I think people under prepare and underestimate the work involved in raising funds. I made a bunch of spreadsheets that calculate the numbers VCs are most likely to ask for:

    • For me anyway, it’s not about the numbers. it’s about the team and opportunity. Numbers come much later

      • I agree, people implement the idea and think of new ideas, refinements, features, niches, etc. But I am shocked sometimes how unprepared some people are who lobby long and loud for an opportunity to get up at the front and look foolish.

    • Mike Clarke

      Muskie – when I click on your link to the spreadsheets I get a big warning that I should not proceed to the site because it is a reported phishing or other bad stuff??

      • That is disappointing. I don’t know who made such outrageous claims, that is my personal domain, it has been for over a decade, 100s of people if not 1000s have downloaded stuff from my website with no complaints. I do know the spreadsheets use VBA and Microsoft warns you that VBA can do bad stuff when downloaded online. What can I say I don’t do bad stuff, if you want to play with the spreadsheets you have to take the risk. What browser/net nanny software are you using? It seems like someone has been petty/vindictive again as I’m so not a spammer, I despise spammers and online scam artists.

        • Hi when I check it is Norton reporting a re-direct.

        • I’ll ask my webhost. I’ve had the same webhost and domain registar for years. I post and link to some odd stuff sometimes, but I definitely am not engaged in a phishing operation. I don’t even ask for emails when people download Excel spreadsheets…

        • I don’t know why I was flagged, I don’t know why I was unflagged, I swear Norton just made me jump through hoops to get my contact information. You can try my domain again but as of this morning I’m no longer a threat…

        • Chill out and don’t take it personally. Just verify that there is no issue

  • Great post Mark. To add one more aspect to the discussion, building companies to the point where they could be acquired for hundreds of millions of of dollars will almost always require several rounds of capital ($10M to $25M in total funds raised prior to exit is doing it pretty efficiently). Obviously there are exceptions (like Freshbooks!), but this is generally true. That means for the fund in your example, they will probably be investing $4-8M of their fund in each portfolio company if they want to own 15%-20% of the company at the point of exit, so say $6M per company on average, which means they will likely be investing in ~15 deals over the life of the fund. Since a fund this size will have around 3 investing Partners and be making new investments over say 4-5 years, each Partner is probably only doing 1 new deal per year. So across the hundreds of companies a Partner will see in a year, they can probably only pick one and if your company doesn’t have that outlier potential, for all the economic reasons outlined above, you are not going to be that one.

    • Absolutely Brian. You’re right. That really puts the challenge in another light. If a partner has one bullet per year, they’re going to choose it wisely.

  • Hi Mark, I agree this is definitely what drives much of VCs filter. Let’s not forget that it is typical nowadays for funds to have hurdle rates as well (say 5%) so before the VCs can participate in any carry they need to deliver a 5% preferred return to their own investors. So the bar is even higher when that is applied over a decade. Also, the exits you mention were in 2011, not 2012. We saw a couple of good smaller exits in 2012, which of course is great for the ecosystem, but we had a serious lack of hundred million dollar plus exits. It wasn’t a great year for exits in Canada last year, unfortunately. And the harsh reality is, without a vibrant IPO market, it is near impossible to triple a venture fund. But we must continue to focus on building value in our companies and making sure they have the capital and options to go for bigger exits and hope for some luck with the public markets. I’ve said elsewhere that I think we have a couple dozen companies in Canada right now that could be billion dollar+ companies. Many of us are lucky enough to be focused on investing in new companies, but collectively we all have to focus on getting many of those to huge exits. It will solve a lot of the problems and issues our Canadian ecosystem faces.

    • Great comments Roger. I didn’t want to over complicate things with the hurdle rate issue. but that is a big factor for sure. Completely agree with you about the IPO issue too. One of the big reasons why I have joined FreshBooks is that I want to contribute to building a huge tech success. We need more of these up here.