Venture Capital Fund Modelling: Masterclass
Part I: Calculated the Average Check Size For Startups | VC Remote Job Opportunity
Are you a startup founder, an angel investor, or an avid enthusiast of venture capital? If you've ever wondered about the intricate process of how venture capital funds determine the investment amount in a startup, then you're in for a treat.
In this post, we'll embark on a deep dive into this fascinating topic and unravel the secrets behind it, all while illustrating a compelling example. Get ready to gain valuable insights into the world of venture capital fund modelling and discover the inner workings of investment decisions. Let's begin our exploration and demystify the process together!
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Let’s deep into the fund modelling
Suppose, the fund, The Venture Crew has a fund size of $100 M and targeting to invest in around 20 companies.
So, you might think the average check size = $100M / 20 = $5 M: Average check size would be $5M and you might be thinking that it’s easy, but the calculation and approach are wrong. Because here we haven’t considered the Operating expenses or the fees charged by the VC fund. So, let’s consider all the costs for the VC fund and deduce it from the fund size.
Generally, the management fees which are taken by most of the funds are around 2% of the fund size annually and considered the fund period of 10 years.
So, management fees = 2% * $100 M = $2M / year. This will be charged by vc fund to manage their expenses. So, as the fund period is for 10 years, the fees for the 10 years will be = $20 M for 10 years. So, let’s deduce the fees from the fund size and look into the average cheque size:
Therefore, the average check size = ($100M - $20M) / 20Comapnies = $4 M. Now the average check size to invest in a company is around $4M. Isn’t it easy, but this approach is also wrong as we didn’t consider the follow-on and investment amount that decide by the VC fund.
If you are not aware of what’s the initial investment amount and follow-on investment in a VC fund? Let me explain these in simple words:
Every VC fund has its own fund period, in which it will utilize all funds to invest in startups and also come up with some return for their investors. As the Venture Crew fund has a fund period of 10 years, they will divide the fund into the two-part - first: the initial investment amount which will invest in the 20 startups in 4-5 years of period and seconds: follow investment which will be invested in the same startup they had invested based on the past performance as it will help to increase the stake in successful companies. So, every fund decides the investment amount and the follow on investment amount depends on the total fund size and agreement with the limited partners.
Let’s assume, the fund The Venture Crew decided to invest 50% of the fund size in the follow-on.
So, the amount reserved for the follow-on investment = 50% * 100 M = $50M. And Remaining net amount = $100M - $50M(follow-on investment) - $20M (fees for 10 years) = $30M;
$30M will be invested in the companies as the initial investment amount in 20 companies within a span of 4-5 years.
So, the average check size = $30M / 20 = $1.5M (This is the accurate calculation for VC Opened Fund’s average check size).
Also, different investors can think about the follow-on investment amount in various strategic way, as the follow-on investment amount help the venture capital to filter out the losers and invest only in winners. The other way to think about the follow-on investment amount - VC want to invest $2 for each $1 initial investment. Then the average check size is less than $1.5M. How? -
As VC want to invest $2 in follow-on investment for each $1 investment in the Initial investment. As 2:1 => (20 *1.5*2) = $60M but we have $50M.
Hence average cheque size = $50M / (20 *2) = $1.25M.
That’s it. Hope this helps you to understand - how venture capital comes up with the average check size. Let me summarize this -
Fund size ($100M) (A) → Subtract all management fees for the 10-year fund period (B) → Divide the new fund amount into the initial investment amount and follow on the investment amount which depends on the fund to fund → Subtract the follow-on investment amount from the (B) fund amount (C) → Divide the C fund size to the number of companies you want to invest.
I hope this article helped you understand some basic VC concepts. If you have any questions or suggestions for topics for our next newsletter, please add them in the comments.
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