The Fiction of 20%

It’s a “given” in the venture business that in order to compensate a venture firm for all the time and energy they are going to put into a particular investment, they need to own at least 20% of the company and ideally 30%.

I hear it all the time.

“We won’t do a deal unless we can own 20%”

“This term sheet has us at 22% which is well below our target ownership of 25%”

“I can’t make a venture return owning just 15% of the business”

To which I say RUBBISH. Just because you WANT to own 20-30% of a business doesn’t mean you NEED to own 20-30% of the business.

The Flatiron program that I still manage owned about 14% of comScore when it went public. 14% of comScore is worth about $120 million today. I don’t want to get into confidential data about how much we invested and how much we took out, but I will say that it was a fantastic investment. I think that is fair compensation for the eight years I put into that investment. And let me tell you, I worked as hard on comScore as any deal I have ever worked on.

Union Square Ventures owned about 14% of TACODA when it was sold to AOL. We returned more money to our investors on that one single investment than they had invested to date in our entire fund at the time of the sale. That sounds like a venture return to me.

Those are two recent examples. But I could go on and on. I have made vastly more money on companies where our firm owned 15% than on companies where our firm owned 20% or more.

To some extent the desire to own large chunks of companies is related to the size of the funds that many venture firms manage. A $120 million position in a recently IPO’d company might not be that interesting to a fund that is managing billions of dollars of investor’s capital. But it sure is interesting to me.

One of the things we are doing in the venture capital business by raising ever larger fund sizes and amassing larger pools of capital under management is creating problems and then making them the entrepreneur’s problem.

And so we tell the entrepreneur that we need 20% of his or her company to solve our problem. I don’t think that’s right. I’ve said this before and I am going to say it again. The scarce resource in the venture capital business is great entrepreneurs with cutting edge ideas willing to work 100 hour weeks turning the ideas into businesses. The scarce resource is not capital and yet we are optimizing our businesses to be able to manage ever larger sums of capital.

I want to optimize our businesss to be able to back more and better entrepreneurs. And so I think its fine to start with significantly less than 20%. We often start our investments off with 10% or less and build our ownerships over time. We have one company in our portfolio where we started with about 5% ownership and are now close to 20% and if we do our job right, we will end up with close to 25%. But we earned the right to get there by investing early and often and scaling our investment with the entrepreneur’s capital needs.

Don’t get me wrong, I would love to own 25% of a company or more. But we don’t make it a requirement. Our requirement is being able to get into the best deals, work with the best entrepreneurs, and be able to generate $40-50mm in proceeds when a deal works and return the fund, $125mm in our case, on the very best deal in the fund.

And you don’t need to own 20%+ of a company to do that. I have 21 years of venture capital investment data to prove it.