It’s really hard to make money in VC

By make money, I mean money-over-over, they got back more than they put in. Seriously ask any of your friends who invest if they actually know someone and they’ll most likely have to think about it and get back to you.

So why am I saying thing about the industry I’m in and have devoted most of my professional career to? Because it’s the truth and if you’re going to work in our crazy, fast-paced and sometimes nonsensical world, you better know how it works. This goes for future founder AND investors.

We need OUTSIZED returns!

When I meet with a founder and go through their deck to find out that in 3–5yrs they’re only planning to generate a few million in revenue, that’s a huge red flag. We want to see your plan to generate $50M in 5yrs — that means you’ve become a player in your industry, you have amazing customers and figured something out. Anything less than that isn’t worth our time.

Assume you’re a $10M micro VC fund and you invest $250k in a startup at a $5M valuation, they don’t raise any more capital and they get acquired five years later for $100M. You just got 20x on your investment, which is amazing and returned $5M to the fund! That’s only half your fund returned on an amazing investment/exit…

By year five you’ve probably already made 20ish investments of $250k, so you’ve invested $5–7M and already spent $1M on management fee (2% a year). That leaves you with $1M ish to do follow on pro-rata to double down on your winning investments.

Assuming 20 investments, we can easily say 15 won’t return anything and you had one 20x that returned $5M. So that leaves you with four that need to return combined over $15M in the next few years to at least double your fund. May the odds ever be in your favor.

http://www.industryventures.com/2017/02/07/the-venture-capital-risk-and-return-matrix/

This is just simple pre-seed/seed math, which changes a little when you start to get into the $100M+ funds. And as you can see here from PitchBook, times to exit/IPO continue to increase thanks to them staying private longer aka The SoftBank Effect.

https://pitchbook.com/news/articles/vc-investment-to-exit-ratio-in-the-us-at-record-high

So why is everyone so crazy about crypto?

Besides the fact that it’s the new shiny trend right now, it’s the only one that provides liquidity on demand (to some extent). This is truly a phenomenon that our industry has never really seen before — generally we invest and the only three ways to get capital out are acquisition, IPO or buyout/secondary. So what do you do as an investor…

You have to consider every option.

While crypto is hot, everyone is trying to find the best projects (reading really bad white-papers) to invest in. Currently ICOs are the preferred method of investment that are contrarian to current investment standards because they don’t require selling any equity in your company, giving legal rights or board seats (control) to any investors. I understand most of the angst behind that reasoning as we move more into uncharted territory, where we love to play. So if I can invest in an ICO when there is a lot of hype, crazy amounts of capital are being poured in and I can sell my holdings (theoretically) whenever I want, why wouldn’t I? Even if it goes down, I can still take out some capital.

I would confidently say that most major funds will make a few investments in the space but my no means allocate a disproportionate amount to it. There is a lot of hype though, so it will have some side-affects on the industry.

*Random side thought — It’s going to be super interesting to watch investors who are up like ~20x on their ICO/crypto whatever investment and see what they do. Do you sell some, all or hodl for more? In traditional venture we don’t have that choice, so we just hold until we’re told what we get. Some crypto VC investors are going to have some sleepless nights when their investments make unicorn like status… would you have sold Uber at $1B or waited until $70B? Also considering anyone can basically buy/sell the tokens, you have to worry about just random people selling and crashing the value. Good luck!

So what does this mean for pre-seed/seed startups?

I tweeted this out as it’s something I’ve been noticing — while pre-seed/seed investment volume has stayed relatively flat, crpyto is only going to make it worse. It has invaded our lives and is sucking all the air out of the room, which is taking our attention away from other opportunities. This will only make it harder to raise capital if you’re just “another xyz” startup.

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I feel bad for pre-seed/seed startups right now as it's harder than ever to raise $. Everyone is so obsessed with crypto that it is taking $, time and focus away from everything else. It will calm down in a few months but it's all about timing.

 — @trace_cohen

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My advice to startups/founders: If you’re out looking for capital right now, you better be really polished, prepared, have more traction than you previously expected and know exactly how you’re going to make it big. I expect in the next six months, a good amount of startups that normally would have had a chance to get funded will go out of business. Think of this as almost a recession like investment environment — until crypto fades a little and/or there is more liquidity (so much capital locked up), we’re going to want less risk.

As always, I’m happy to help and provide feedback to get you into a stronger position to raise capital. A lot of people reached out after my last post and I noticed a few things missing that you NEED to know/have:

• Team slide needs to be solid — humble brag and tell us why you’re amazing! It’s hard to write about yourself but we bet on you.
• Financials — Don’t make me do math and make assumptions. Make it very clear what you’ve done so far, what you plan to do and how you will get there.
• Terms — This is your company and you set the terms. An investor can suggest otherwise but I want to know what you think you’re worth and how much you need to grow this.
• Partnerships — Putting logos on a slide doesn’t help, so please quantify your relationship or deal with them.

It’s really hard to make money in VC was originally published in Hacker Noon on Medium, where people are continuing the conversation by highlighting and responding to this story.