Entreprenuer Bill of Rights ARTICLE 2: The right to take only as much money as needed December 14, 2009Posted by Lawrence Lenihan in Uncategorized.
There is a myth that somehow developed in the land of venture capital that a VC has to put in a certain amount of capital or own a certain percent of the company. This may be a certain criterion for certain VC firms, but I have never heard it from an LP in my 13 years of being a VC.
So why did we VC’S, essentially, make this up? For a number of reasons. First, if we are going to spend our time with you, we need to make it worth our while (see VCBR#2 that will come out tomorrow). Super model Linda Evangelista once said that she would not get out of bed for less than $10,000. I don’t know any super model’s who are now VC’s, but it’s kind of the same thing. What has happened though, is that this requirement has been translated into the amount of capital in rather than the potential capital out. The two may not actually be related, especially when companies can be built with so little capital.
What happens is that VC’s have a certain fund size. We have a certain number of partners. Each partner has a certain capacity. If you divide the fund size by the product of partner capacity per year, number of years during the fund investment period and the number of partners, you will get the investment size requirements. For example, in a $600MM fund with eight partners who can manage 1.5 new investments per year and whose fund has an investment period of 4 years, the answer is $600MM/(8*1.5*4) = $12.5MM per investment. Now, for early stage investors, this figure is over the life of the investment and the initial round would be less. But, you get the idea of how this works. So, the fund size is what is driving the round size or, in other words, the conditions that we VC’s created are driving the condition that we are now requiring that you accommodate!
The ownership level is a true artificial constraint. We don’t have to own a certain percentage. Sure, our LPs ask us what our targets levels of ownership are, but we could give any answer and justify it. However, the one aspect of the investment that is driven by ownership level is governance. We will always require special governance provisions that enable us to protect our rights and drive to an outcome. Do we need to own a certain percentage of the company to gain these rights? Sometimes, but that is an issue that can be addressed between the entrepreneur and the VC without having to overcapitalize the company.
So, in the end, the entrepreneur should have the right to control how much capital he/she takes based on the company’s needs, not the constraints that the venture capitalist set up for himself/herself.