Deal Size
Brad and I have been doing early stage investing since the late 80s (me) and early 90s (Brad). For most of our career, a typical early stage venture round was $5mm to $6mm and you'd put two firms together and each would invest $2.5mm to $3mm.
So when we sat down to build the business plan for Union Square Ventures, we started with that model. But recognizing that we were focusing on a sector (web services) which could be a lot more capital efficient, we put another kind of investment in the model, the $1mm investment. We assumed that about 25% of our investments would start with much smaller bite sizes.
We are about half way through building our portfolio and here is the distribution of initial investment sizes (I am including one investment we are about to close in here as well):
Below $500k - 2
$500k to $1mm - 2
$1mm to $2mm - 2
$2mm to $3mm - 2
Above $3mm - 1
So what this says is we are starting our investment positions in our portfolio companies with $1mm and under investments almost half of the time. And the $2.5mm to $3mm starting investment (traditionally the typical Series A round bite size) is only about one third of what we are doing these days.
That is a departure. Maybe a significant departure. But we are comfortable with it because we are seeing that we are able to obtain our target ownership levels of 15% to 20% even with these smaller investments (although sometimes it takes us a couple rounds to get there).
It also allows us to take more risk, whether it be management team risk, service adoption risk, market size risk, business model risk, or some other risk or combination of the above.
When the amount of capital we have at risk is low, we can try some things that we would not be comfortable trying with $2.5mm to $3mm invested. So it allows us to get involved in things that are farther out on the risk curve with potentially more upside if things work out.
The most important factor, however, is the capital efficiency we are seeing in our portfolio companies. They simply don't need as much money as the companies we backed 5 years ago, 10 years ago, or 15 years ago. They may need as much capital when they become big businesses and need to invest to grow. But the clearly do not need as much capital to get from idea to commercial launch and to revenues.
We could go into all the reasons why that is the case, but we have addressed them in the past on this blog and elsewhere and we want to keep these posts relatively short and sweet.
We are generally not putting up all the capital in the rounds we are leading. We often will take between 50% and 60% of the round. We have done closer to 80% of the round in a couple of situations. We like to find another venture capital firm to invest alongside of us in these rounds, but given the deal sizes, that sometimes will not work and we have invested alongside angels in three of our initial investments. We have also partnered with strategic investors three times.
So you can multiply the numbers in the list at the beginning of this post by 1.5 to 2x to see the typical round sizes we are leading. That said, we have not participated in an initial round larger than $5mm yet in this fund. That is not to say we wouldn't do it, but we haven't yet and it would take something particularly interesting to get us to do it.
Does this make Union Square Ventures a "seed fund". We don't think so. We have led investments in companies with significant revenues on multiple occasions. And we think we will be able to (over time) get $5mm to $8mm invested in our portfolio companies and we are already there with one of them . We can invest up to $20mm in any single company in the portfolio. So we are not a "seed fund".
We think this approach makes us an early stage fund that believes in raising only enough money to achieve a set of near term milestones which should significantly impact valuation. That's really classic early stage investing. Only we think we may now be able to start with a lot less at risk in the markets we are focusing on. And that's a good thing.
October 24, 2006 05:21 PM, By Fred Wilson
Tags: amount dealsize round seriesa
Comments (8)
Fred --
Isn't this also the exact bookend to the NY Times story on Sevin Rosen? The capitalization model has indeed changed for the kinds of companies you have funded throughout your career. You and Brad have subsequently changed your model -- your way of doing business -- that allows you to still achieve your target returns given this change. And one of the most important ways you've done it is through the ability to make much smaller investments and invest less over the life of a company and make that "work." My guess is you probably couldn't be doing that with the overhead, staffing, and fund size of a Sevin Rosen.
So you guys have adjusted to the market -- and it is working -- just like successful portfolio companies need to do.
Posted by AlFromChicago , October 25, 2006 09:57 AM
Only problem with this strategy is that you're not putting much capital to work for your LP's -- around $15MM in total for the portfolio you described (yes, I know that you'll ideally invest larger chunks in follow-on rounds).
Posted by KD , October 25, 2006 12:02 PM
Two key attributes of web services startups are that the capital requirements are lower and mainly go towards talent. So why isn't this offshored?
I think it makes sense to set up offices in Russia or India and then choose a greater number of deals for $1mm or less, with the requirement that the founder(s) move to the offshore location and use the talent there for the duration of the initial build period. This could cut the deal down by 1/10th, making possible ten times the number of deals, increasing the hit percentage.
Posted by David , October 26, 2006 08:00 AM
I'm not sure I go along with David. I'm providing the proof of concept (POC) capital for two ventures. $50K - $100K each. Since I am an active investor, for this phase (at least) I want the key person(s) nearby.
For me this phase is not only about feasibility and marketability of the concept but it is about learning more about the founder(s). If they are first-timers there isn't a track record to go on. And I need to verify to my satisfaction all the good stuff I have heard. Because if the POC looks good I (and perhaps some friends) will stump a lot more money for the next phase.
Go foreign? Maybe. But I don't want to spend the time and money going abroad when these early steps are the most important in assessing my new partner(s) and being certain (s.t. my own limitations) that we are on the right track.
Posted by Leon Liebman , October 26, 2006 08:39 AM
That answers my question, Leon. While I was thinking more of the phase that follows POC, and while I still think it somehow could be a valid option for the changing face of VC, I'm sure you're right that the lack of control simply increases the risk too much. Thanks.
Posted by David , October 26, 2006 09:17 AM
Don't you feel that there will always be a significant difference in the investment attitude of VC's and Angel Investors, no matter the actual $ value of the investment?
How often will you see a VC go down to the level or Friends & Family investors (who invest without any actual revenue in sight). Angel investors often go down that page.
Posted by Vinit , November 1, 2006 07:50 PM
Six of one and half a dozen of the other... Roger
Posted by Roger , November 30, 2006 08:16 AM
How do you make the managment fee work? NYC is not a cheap place to keep an office.
2% (typically) * 10 investments * $5M each = $1M mgmt fee.
$1M / ( 2 partners + 2 Staff + Office + Legal + Travel )
Apparently you make it work, or my numbers or wrong somewhere...
Posted by PRoales , October 25, 2006 09:06 AM