GUEST COLUMNS
You Don’t Need Venture Capital As told by a venture capitalist By FURUZONFAR ZEHNI
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ntrepreneurship comes in all colors and flavors. Not every business has to raise US$20 billion dollars from visionary funds. There are plenty of impactful, sustainable, and large companies that are changing people’s lives without venture funding. Before listing a few of these businesses, let me explain my thought process. Disclaimer: I work at an early stage venture fund, Fresco Capital. We meet with about 1,500 companies annually. Now that’s out of the way: in this column, we will go over what kind of companies should raise from venture capitalists (VCs), from a nerdy VC’s point of view. We will then touch on companies that never raised from VCs, but are incredibly successful.
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JUMPSTART MAGAZINE
April 2019
First, we have to understand a notable key performance indicator (KPI) for venture funds: multiples. It’s the number of times the initial injection of capital multiplies over the investment’s lifetime, and on a more macro level — the multiple of the total portfolio. VCs look at multiples because startups are risky investments. The second definition we have to understand is the impairment ratio, or the total amount of capital in investments valued below their initial investment value. In a typical venture portfolio, one-third will generate zero return, one-third will generate one time the return, and the remaining one-third will–by necessity– generate most of the return, making your impairment ratio around 50%. Having identified two notable components that make up the venture frame-
work, we can now create a hypothetical scenario: Your fund, Future Fund II, has $100 million to invest. Your limited partners (LPs), or investors that give investors money, expect you to generate three times the return on their commitment ($300 million) by year ten. As a fund manager, you decide to make ten investments. A third of those investments generate no return, so that’s $33 million gone. A third return their initial investment —you have $33 million in the bank, great. Now, you have to generate $267 million with the remaining $33 million, which is more than eight times your initial investment. Let’s take a closer look at those remaining three companies. With a $10 million investment, you might get about 20% of the company–that is if all goes well. Considering this 20% ownership, you would need the combined valuation of the companies to be $1.3 billion to return enough capital to your fund, so you hit that target for your LPs. If one of those companies is valued above $1 billion–that’s unicorn status. There are about 300 million companies out there. Only 325 are unicorns. Building one is super difficult, and getting to invest in one is almost as difficult. Thus,
