Does the Size of a VC Fund Matter?

Posted on Apr 2, 2010 | 23 comments


how big is my fundThis is part of my series on Understanding Venture Capital.  I’m writing this series because if you better understand how VC firms work you can better target which firms make sense for you to speak with.

It is not uncommon to see a VC talk about “total assets under management” as in “We have $1.5 billion under management.”  I don’t really understand why VCs do this since it’s mostly a meaningless number.   I’m writing this post to explain to entrepreneurs what you should be thinking about in terms of the VC’s you approach and the size and stage of their funds.

What is total assets under management? - VC’s often talk about this term as in the total amount of funds EVER raised by that VC.  Example: if a VC is on their fourth $200 million fund that they just raised in 2009 then you might hear them talk about $800 million under management.  This is ONLY relevant in so much as it will tell you that they’ve been able to raise a lot of money historically.  But without knowing whether they had a $700 million fund and now have a $100 million fund or whether they’re a first time fund of $800 million it’s pretty meaningless.  It’s also meaningless if they had four $200 million funds and the last one they closed was in 2000.

What is a VC fund? – I’ll do a detailed post at a later date but to make sure that everybody has a baseline understand for the more important details of this post I’ll touch on this topic here.  VC’s don’t invest 100% of their own money.  They raise money from institutions who want to have some allocation of their investment dollars in a category known as “alternatives,” which is supposed to mean higher risk, higher returns.  Unfortunately over the period of 2000-2010 the VC industry hasn’t performed well and therefore the number of funds going forward is likely to reduce greatly.  VC’s raise this money from university endowments, public & private pension funds, insurance companies, banks who invest from their balance sheet or that of their wealthy clients, “family offices” which means money from very wealthy people, etc.  And funds also have investments from the partners of the firm.  Most funds are 10 years in length and the initial investment period is normally 3-5 years.  So VCs often raise money every 3-5 years if they can.  Some wait 5-7 years but usually this is because it’s proving more difficult to raise a new fund due to market conditions or the lack of returns in their current fund.

What IS relevant about the size of a VC’s fund? – The most relevant thing for you to know about size is the dollars of the CURRENT fund.  For example, my firm, GRP Partners, has a $200 million fund that was closed in March 2009 and we have 4 investment partners.  Our prior fund was $360+ million and the fund before that was around $200 million.  The size of those prior funds doesn’t really matter to you.  What you really want to know is that our current fund is $200 million and you want to know when it was raised (covered in next section).  If a fund has a $25 million fund then you know they aren’t going to be writing $5 million checks!  A fund size of $25 – $100 million is normally an “early stage” fund that is likely to do seed investments and/or smaller A round investments.  A fund size of $100 million – $200 million is likely to either be an A round investor or “stage agnostic”.  An A round investor implies they are the “first institutional money in the deal.”  GRP Partners is stage agnostic.  We’ll invest $500k in a seed stage deal, $2 million in an A round or $8-10 million in a B round investment or later.

If you see a fund of $600 million you can bet that it’s harder for them to do $1 million investments so it won’t be uncommon for you to hear them talking of “putting more capital to work” which is code for “I can’t really get out of bed unless I’m putting at least $2-3 million into your company.”  It’s not always the case.  But it’s worth your knowing that the larger the fund size the more pressure the fund will have to shy away from investments that are too small.  You can always talk to your VC about the “stage” (seed, A, B, C) of deals they like to do and their “typical first investment size.”  All quotes in this post are VC lingo.

Understanding the fund vintage – “Vintage” of a fund refers to when the fund was raised.  A 1997 vintage is likely to perform much better than a 2000 vintage because the former got to ride the dot com bonanza and likely saw some quick IPOs and crazy trade sales while the latter is more likely filled with many companies that never reached the promise land (or are still trying).  Why does vintage matter to you? If the VC your talking to raised its last fund in 2002 then they likely don’t have much fire power for new investments.  I wouldn’t say the have NO firepower but it’s not likely a lot left.  If you imagine that they did most of their initial investments between 2002-2007 then it’s been 3 years of mostly doing follow-on investments in those old deals.  Also, since most funds are 10-year funds there will be pressure in 2012 for this fund to start exiting its investments and return money to its shareholders.  Most funds get annual extensions.  I’m not an expert in this fields but ironically I’m finding the most “10-year funds” are really more like 13 year funds.  But let’s just say I wouldn’t want to take an A round investment from a firm who is in year 8 of their fund without really understanding this.  If they’re likely to raise a new fund then you might be OK but at least have the conversation with them.  And know that raising new VC funds right now is incredibly hard.

How much of a fund is actually invested in new deals? – If a VC has a $150 million fund (let’s call the VC-A) to  they might only invest $75 million in new deals. Maybe even less.  Let’s say a fund invests $1 million in an A round deal in a company called NewCo.  That fund “reserves” money for NewCo’s “follow on” investments.  In an early stage deal that fund might reserve 2x their initial investment or if it’s a larger round or later stage they might reserve 1x.  In the 2x example that means that VC-A has really blocked out $3 million from their fund ($1 million invested, $2 million reserved for NewCo.)  They might never invest that $2 million and over time they might adjust that reserve (up or down).  The main take-away for you is that a $150 million fund is not $150 million of new investments.  You want to know how much money is “not reserved.”

Knowing the “number of deals left in the fund” – VC’s typically talk among themselves about “the number of deals left in their fund” as in a $200 million fund with a vintage of 2006 saying, “we have about 4 new deals left in our fund.”  In that number they have to include the amount of the new investment they plan to make plus the amount they would reserve for those new investments.  VC’s don’t publicly state this number so don’t expect to find it on their website and don’t blurt out the question in your first meeting with them.  But know that for funds that aren’t closed within the past 3-4 years … the VC will know this number.

Will your VC be able to raise another fund? – That’s a tough question that as of 2010 is a hard to know for certain.  The industry is in turmoil, for sure. Paul Kedrosky wrote a seminal paper for the Kauffman Foundation saying that the VC industry needs to shrink by 50%. Fred Wilson also wrote a sophisticated analysis of why he believes the market must normalize to smaller amount of money going into VC firms.  Fred echoes my view that fewer firms is good for the industry and good for the companies we fund.  Irrational prices and over investment in your competitors hurts your ability to build healthy businesses.  I saw it myself in 1999-2002 when it was hard to charge for my product because all of my competitors raised large rounds of capital and were giving away their products free fueled by large VC rounds.

If a VC fund you’re talking to raised a fund in 2005 or early and hasn’t yet raised a new fund they certainly will be thinking about it and trying to figure out how and when to raise a fund.  What will matter are: whether the people who invest in VC funds (LPs or Limited Partners) increase their activity and the performance of that actual fund.  What the LPs will be looking for are VCs with enough “exits” to prove that they can make returns.  So look at the latest portfolio of your VC (not prior funds) and see whether they’ve had exits and how many of their non-exited companies are likely to exit in the near future.

I wouldn’t rule any decent firms out.  I know many great funds that haven’t yet raised their new fund but may still get there.  A lot will depend on how exits go in 2010/2011.  GRP’s last fund was in 2000.  When GRP talked to LPs about a new fund in 2005 the feedback was “get some more exits in your fund and then come back.”  That’s what many VCs are hearing in 2010.  I’m happy to say that in 2006-2008 we has some good exits including BillMeLater, DealerTrack, UGO Networks and PrePay Technologies to name a few.  We also took one of our large portfolio companies, Ulta, public.  Our 2000 fund is now performing significantly above industry averages and therefore we were able to raise a new fund in tumultuous times.

How and when can you ask all of these delicate questions – You can’t blurt out all of these questions in your first meeting.  But you can do some focused Internet-based research before approaching the firms.  You can ask around to startup lawyers and other entrepreneurs who know these things.  And if your friendly with somebody at a VC firm they usually know the high-level details about the other firms.  The right time to start asking about these sensitive questions is when the VC starts showing interest in your company.  Ask delicately and respectfully.  But make sure you answer all of the important questions about when their last fund was raised, how big the fund size was, how many investments are left and when they will likely raise their next fund (assuming this fund wasn’t closed in 2007 or beyond).

  • http://www.joaobelo.co.uk/ Joao Belo

    A good VC needs to have money for additional funding rounds. Larger VCs even go all the way and have their own, larger, Growth Capital funds that allow their smaller early stage funds to exit, making sure they have funding solutions available for all the growth stages up to IPO/trade exit.
    Entrepreneurs definitely need to research VCs, understand their business model and how they can add value beyond funding, their relationships with other VCs… and aim for the best fit. Again I believe networking early on with VCs is very important to try to understand their abilities, positioning, access to further funding, etc.
    So far I've found VCs are quite open to speaking about their fund raising and how they work, so hopefully this should be an easy task.

  • http://www.kidmercuryblog.com kidmercury

    interesting post mark. as you noted how public and private pension funds invest in VC funds, i wanted to note one meme that has been going around kook circles a bit more of late, which is that as the economic crisis worsens, pension funds will get nationalized. this will be spun as a positive thing (“we had to do it to save the economy….it's for the good of the children”), though kooks will be more inclined to perceive it as theft of the private sector and a handout to government and its owners. argentina nationalized pensions in the face of their crisis.

    http://www.sodahead.com/united-states/will-obam
    http://online.wsj.com/article/SB122460155879054

  • http://cloudcomputing.blogspot.com/ Chirag Mehta

    As usual, great post Mike!

    Could you please elaborate on the impact on entrepreneurs of late stage start-ups that have been funded by the VCs who are under pressure from the LP for more exits? I see quite a few late stage start-ups in the valley that are growing well in revenue and market share but don't yet have positive cash-flow. If these companies are forced to “exit”, through an acquisition, they might be compromising on future potential. Raising more VC money may or may not be an option for them and they may not be ready for an IPO. How would you suggest they deal with this situation? What do you think of strategic or mezzanine rounds in this case?

  • dereklicciardi

    Something about that top image made me want to sing the $5 dollar footlong Subway theme song.

    Another great post. How much of an impact does the current performance of the fund have on the risk VC is willing to take with the remaining deals in the fund? If the early bets are not paying off as well, do VC try to make up the difference with added risk or do they tend to go conservative and play not to lose too much more on new deals? Conversely, do they build on succes or hedge against failure if early investments pay off? There has to be a promised rate of return for funds in the VC asset class, so I'm curious to know how the current performance of a fund impacts the thinking of the investors and LPs over the life of the fund when evaluating the remaining deals in the fund.

  • http://www.joaobelo.co.uk/ Joao Belo

    A good VC needs to have money for additional funding rounds. Larger VCs even go all the way and have their own, larger, Growth Capital funds that allow their smaller early stage funds to exit, making sure they have funding solutions available for all the growth stages up to IPO/trade exit.
    Entrepreneurs definitely need to research VCs, understand their business model and how they can add value beyond funding, their relationships with other VCs… and aim for the best fit. Again I believe networking early on with VCs is very important to try to understand their abilities, positioning, access to further funding, etc.
    So far I've found VCs are quite open to speaking about their fund raising and how they work, so hopefully this should be an easy task.

  • bsrubin

    Nice job Mark – this jives with my experiences as an entrepreneur raising capital. I'm savvy about this now – but 4-5 years ago when raising our first venture round I can see in hindsight how poor a fit some of the firms we approached were – too big/small or too stale. When I give advice these days on firms to approach along with the standard industry/stage filters I mention current fund size (under management is irrelevant) and vintage. On vintage and size my rule of thumb is 'raised within 5 years' and 'target 2%-7% of the fund being put to work in your company'. Not sure about the second rule of thumb being on – exceptions are common.

  • http://www.kidmercuryblog.com kidmercury

    interesting post mark. as you noted how public and private pension funds invest in VC funds, i wanted to note one meme that has been going around kook circles a bit more of late, which is that as the economic crisis worsens, pension funds will get nationalized. this will be spun as a positive thing (“we had to do it to save the economy….it's for the good of the children”), though kooks will be more inclined to perceive it as theft of the private sector and a handout to government and its owners. argentina nationalized pensions in the face of their crisis.

    http://www.sodahead.com/united-states/will-obam
    http://online.wsj.com/article/SB122460155879054

  • http://cloudcomputing.blogspot.com/ Chirag Mehta

    As usual, great post Mike!

    Could you please elaborate on the impact on entrepreneurs of late stage start-ups that have been funded by the VCs who are under pressure from the LP for more exits? I see quite a few late stage start-ups in the valley that are growing well in revenue and market share but don't yet have positive cash-flow. If these companies are forced to “exit”, through an acquisition, they might be compromising on future potential. Raising more VC money may or may not be an option for them and they may not be ready for an IPO. How would you suggest they deal with this situation? What do you think of strategic or mezzanine rounds in this case?

  • http://how2startup.com/ Roy Rodenstein

    Great overview of a very advanced and litte-discussed topic. Unfortunately even knowing the answers to all these questions things can get messy over time. A company in your vintage may need a $100M round and greatly exceed its reserve, or your company may go long enough that its vintage fund gets cramped and you may get painted into a corner for followons. Even more complicated, VCs often invest from multiple funds or sub-funds into a single deal. So as an entrepreneur it's hard to navigate those waters over time. As usual the rule is, if you're doing well, they'll find the money for your next round.

  • dereklicciardi

    Something about that top image made me want to sing the $5 dollar footlong Subway theme song.

    Another great post. How much of an impact does the current performance of the fund have on the risk VC is willing to take with the remaining deals in the fund? If the early bets are not paying off as well, do VC try to make up the difference with added risk or do they tend to go conservative and play not to lose too much more on new deals? Conversely, do they build on succes or hedge against failure if early investments pay off? There has to be a promised rate of return for funds in the VC asset class, so I'm curious to know how the current performance of a fund impacts the thinking of the investors and LPs over the life of the fund when evaluating the remaining deals in the fund.

  • bsrubin

    Nice job Mark – this jives with my experiences as an entrepreneur raising capital. I'm savvy about this now – but 4-5 years ago when raising our first venture round I can see in hindsight how poor a fit some of the firms we approached were – too big/small or too stale. When I give advice these days on firms to approach along with the standard industry/stage filters I mention current fund size (under management is irrelevant) and vintage. On vintage and size my rule of thumb is 'raised within 5 years' and 'target 2%-7% of the fund being put to work in your company'. Not sure about the second rule of thumb being on – exceptions are common.

  • http://bothsidesofthetable.com msuster

    Mezz rounds seem more common these days and often have an amount of “founder liquidity.” But one other point I'd like to make … some VC's will sell their portfolios to “secondary investors.” This happened after the dot com crash, too. The way this works is that if a VC has 12 remaining investments a secondary fund will give them a certain amount of pennies on the dollar for all of their companies. That could mean 20 cents on the dollar or 50-60 cents on the dollar. In this case the startup isn't immediately impacted financially but might find that they have another “wife” or “husband” than they expected at the time they got married. This one might be prettier or might be a drunk.

  • http://bothsidesofthetable.com msuster

    Yes, performance of the fund matters. If they've already exited a number of investments they're more likely to be able to raise another fund and therefore less under pressure to see an exit from your company.

  • http://bothsidesofthetable.com msuster

    All three of your points seem about right. Thanks for the contribution.

  • http://bothsidesofthetable.com msuster

    Thanks, Roy. Good poitns. I'm going to cover some of these topics in future posts so I'll leave it for now.

  • http://how2startup.com/ Roy Rodenstein

    Great overview of a very advanced and litte-discussed topic. Unfortunately even knowing the answers to all these questions things can get messy over time. A company in your vintage may need a $100M round and greatly exceed its reserve, or your company may go long enough that its vintage fund gets cramped and you may get painted into a corner for followons. Even more complicated, VCs often invest from multiple funds or sub-funds into a single deal. So as an entrepreneur it's hard to navigate those waters over time. As usual the rule is, if you're doing well, they'll find the money for your next round.

  • http://bothsidesofthetable.com msuster

    Mezz rounds seem more common these days and often have an amount of “founder liquidity.” But one other point I'd like to make … some VC's will sell their portfolios to “secondary investors.” This happened after the dot com crash, too. The way this works is that if a VC has 12 remaining investments a secondary fund will give them a certain amount of pennies on the dollar for all of their companies. That could mean 20 cents on the dollar or 50-60 cents on the dollar. In this case the startup isn't immediately impacted financially but might find that they have another “wife” or “husband” than they expected at the time they got married. This one might be prettier or might be a drunk.

  • http://bothsidesofthetable.com msuster

    Yes, performance of the fund matters. If they've already exited a number of investments they're more likely to be able to raise another fund and therefore less under pressure to see an exit from your company.

  • http://bothsidesofthetable.com msuster

    All three of your points seem about right. Thanks for the contribution.

  • http://bothsidesofthetable.com msuster

    Thanks, Roy. Good points. I'm going to cover some of these topics in future posts so I'll leave it for now.

  • http://lmframework.com/blog/about David Semeria

    Great point about this post breaking new ground. I can't remember any similar posts on the various VC blogs.

    Quick question for Mark: is it possible for a VC's investment in a company to span vintages? My initial feeling would be: in theory yes, in practice less likely…

  • http://lmframework.com/blog/about David Semeria

    Great point about this post breaking new ground. I can't remember any similar posts on the various VC blogs.

    Quick question for Mark: is it possible for a VC's investment in a company to span vintages? My initial feeling would be: in theory yes, in practice less likely…

  • http://lmframework.com/blog/about David Semeria

    Great point about this post breaking new ground. I can't remember any similar posts on the various VC blogs.

    Quick question for Mark: is it possible for a VC's investment in a company to span vintages? My initial feeling would be: in theory yes, in practice less likely…