Designing a VC Fund around a Technology Thesis

A small exercise into sizing of a Venture Fund. A hypothetical fund is created based on assumption of talent supply along the Gartner Hype Cycle. From there, the cash demand of the market is calculated and sanity checks on fund sizing are helping to size the P&L and AUM of the fund.

Using a Hype Cycle to Time a Market

Any Venture Capitalist must start small and must have a strong differentiator. One such differentiator is to time a technology cycle very well and be leader in that technology.

  1. Best place to raise and secure the fund stage 1.
  2. Network. This early stage is where the ecosystem develops. Time to build your network get tap into insights and dealflow later.
  3. Close. By the peak here even the slowest corporate got the idea and starts interalizing the ecosystem view. Internal innovators start patching up labs and playing around with the technology. It is the time when your exit markets start forming.
  4. Time. The time and place when and where product-market fit kicks in. First end users start buying minimum viable products around viable value propositions. Corporates and your future exit market starts to understand how the technology works and where it fits into the investor and corporate portfolio. A bit more time, and the buyers know if and waht they want to build or buy. And which parts they do not need.
  5. Make money. Here the future of the industry is laid out already. All the dynamics and structures we see later on are already written into stone and the rest is „emergence“ in the making. Later stage investors start formulating their market thesis and the fundraising funnel carries winners to the end game. Follow on financing is secure now. And the obvious later consolidations in the market is now shielded away by the stickiness of everyones committment. The market has matured.

Market Timing: Information & Cycle Velocity

The next step is to really understand market information and opportunity in this hype cycle dynamics. It is really really essential.

  1. Time to make friends. This is the stage of (a) observing, (b) discovering, tapping into, capturing network access that later will generate deal flow. It is crucial to differentiate core members of the community and seperate true leaders from believers and heretics. The sooner the better. Because at the peak, it will already be very very hard to access the leaders.
  2. What is dead shall never die. In this part of the cylce, basically two things happen: (a) Corporates build bets enshrined into excellence centers, and (b) networks are consolidating and re-grouping. 1.70+% of „leaders“ players will vanish or follow. Who are the < 30%? Don‘t spent time networking the wrong people. 2.Who are the smartest and must trusted sponsors in the corporates? Who has the network? Who has the highest „factor load“ of surviving his career and bet on his reading of the market?
  3. Ready. Set. Run. Whoever doesn‘t run now, will miss the Seed market. Once the product-market fits kicks in and market knows where it is going, there is no more economics for a first time Seed fund. So have your money mice ready.
  4. Appreciation and Traction. Portfolio value apprectiates, traction forms. Now the later stage investors build their wishlists. Time to crank up the AuM and go long on your working portfolio companies. Dress it up. Get into winner cap tables. Drop the dead horses. It‘s the time that defind your fund multiples and carry.
  5. Groom, Loom an Land. Your exit market has formed now. Shoppers are going for a spree. First come first serve Deals. Buy to kill deals. Aquifire, Aquire. It‘s all happening now. The network from step 1 and 2 will help select the groomable companies and the companies will be groomed for exit at this point. Everybody wants money.

Estimate Fund Size via Deal Flow and Talent Pool

Now we look at the size of community / ecosystem participants. Top shows the global and bottom shows local numbers. Of course this is purely random.

So: Why is this relevant?

You want to calculate the number of investment opportunities per year.

  • 5000 people are in the community
  • 500 (10%) actually are core parts
  • 50 (10%) of which have „high level“ of skills. They are core core.
    It is possible to know, identify and network those 50 people.
  • 5 (10%) of core core is building its own companies per year (5).
  • Average team size is 1.8 . So we have 2.9/3 investments per year.

Why do you need this?

  • Now you know how many deals you get per year (DPA) = 3
  • How many % of deals in the market do you want ? 30% = 1
  • How much is the cost of marketing and winning the deals? 10k
  • How much is your marketing in % of OPEX? 5%
  • And how much is your management fee in % of AUM? 5%

If your DAC are 5% of your total OPEX, and your OPEX are 5% of AUM in management fee. If you have 10.000 in DAC, you face 200.000 in OPEX and hance 4 Million is the size of your fund. I mean from a marketing cost perspective, you should not have less.

Does the fund size pan out for your P&L?

So 200k in annual fees. How does this split?

  • 15 in Legal
  • 15 in Tax and Accounting
  • 80 in Base
  • 40 in Bonus
  • 10 in DAC
  • Leaves 40k for PR, Marketing,

That is approx 3k per month for travelling and attending events. And of course, this is a single individual fund entity. Ouch.

So yes, from this perspective the size of the fund and AuM make no sense.

Estimating Fund Size via Deals

Now you have a 4 million fund, you have 5 years to invest in one to two rounds in each investment and want to invest into 1 deal per year. You are following a 1:3 model, so you invest 3 times your initial investment after the first investment.

So 5 investments each getting 800. 200k initial investment and then 800k follow on. You are hence investing in a Seed stage and willing to bridge up to 200k and extend or go follow-on with 400k – 600k in a syndicated Series A deal. That makes sense. This isn’t a law of large number / long tail approach. You really need a good deal flow and good investments.

Estimating Fund Size via Deals

Of course, this all makes no sense. There must be more deals in the market. But having too much AUM and not enough deals is an issue that large later stage funds have for example in Europe. Carlyle and KKR are struggling with there multi-billion dollar growth-focused funds quite a lot and risk over-committing and misallocating.

  1. No Follow-Ons? Don‘t like Monty Hall, do you?   Statistics for VC Starters and this
  2. You don‘t really play cards if you don‘t know how to bridge.  Bridging done right and this
  3. Fixed investment ticket? It‘s called bifurcation. Not fornication.  Size does Matter or this
  4. You don‘t want your PortCo to cliff before the vesting agreement.  Fundraising like Don Juan with Soft Commitments.
  5. You assumed you take 30% of the market and supply 100% of the seed capital. Basics on Syndication Assumptions

Some food for thought

Let‘s say you take the 30% of the market for 3 years, so you write 200k checks. Your syndicate partners don‘t let you in on any winner. You tank 600k of your initial invests and sit on 4.4m dry powder. Ouch. Solution? Left as an exercise….

Or maybe: You invest 50k in initial invests (150k) and have 4.85m reserves left. You typically take 33% in all rounds, which you lead,
and in the initial round you take a fair 20% bite. What growth is needed to allocate te 4.85m in the follow ons if only 2 companies are worht the follow-on?

In all that great visionary thinking you forgot that you don’t dictate the cash needed by these companis via your allocation requirements. You have to find a way to allocate your money based on when companies need which amount of money?

General Context

Fund Sizing via Cash in the Market

The next exercise you can do is find out what levels of cash there are in the market.



Schreibe einen Kommentar

Deine E-Mail-Adresse wird nicht veröffentlicht. Erforderliche Felder sind mit * markiert.

Next Post

Global City Networks

Fr Jul 5 , 2019
This is a copy of an article found under below link with minor comments from my side. The article underlines my thinking on global networks of cities. Intro Systems of cities represent human interaction networks and their connections with the built and natural environments. Logically, the study of city […]

You May Like