Valuation vs Ownership

I am talking at the PreMoney conference today (via Skype) and I woke up thinking about the challenges facing the VC industry. I hope to talk a bit about this at the conference.

Some investors are ownership focused. They want to own 20% of the business but care less about the valuation. Let's take a hypothetical Series A round. An entrepreneur comes to USV and pitches us and we like what the company is doing and we offer $2mm at $8mm pre-money/$10mm post-money. The $2mm buys us 20%.

Another firm shows up, a firm that is less valuation oriented, and they offer $5mm for 20% of the business, which works out to $20mm pre/$25mm post. The entrepreneur suffers the same dilution but gets $3mm more to work with.

From the VC's perspective, there isn't that much difference. Let's say the company sells for $100mm at some point. The first deal would produce $20mm in proceeds at sale, an $18mm gain, and a $3.6mm carry if you charge 20% as we do at USV. The second deal would produce the same $20mm in proceeds, a $15mm gain, and a $3mm carry if the other firm charged 20% carry. If they charged 25%, as many do, then they make $3.75mm, which is more than the $3.6mm.

It's the limited partners who get screwed by this stuff. If they had money in both firms, one deal would have turned $2mm of their money into $16.4mm (8.2x), the other would have turned $5mm of their money into $17mm (3.4x).

And the firm offering $5mm for 20% will likely have a $500mm fund size (or more) and will be making $10mm or more per year in management fees.

This happens all the time in the VC business. And it is why USV is committed to small fund sizes, small rounds, and smaller valuations. We lose a lot of deals to firms who aren't committed to any of those things. But that's life. We have made our LPs a fair bit of money and we expect to make them a lot more in the coming years. We keep the fees low and try to produce big gains. That's our model.

We are also very much focused on what is in the best interest of the entrepreneur. You might ask "how can taking $2mm for 20% be better than taking $5mm for 20%?" and you'd be right asking that question. The answer is you can get the other $3mm later at an even higher price. That has been the history of many of our investments.

We recommend that entrepreneurs keep the funding amounts small in the early rounds when the valuations are lower and then scale up the amounts in the later rounds when it is a lot more clear how money can create value and when the valuations will be higher. This model has worked out pretty well. David Karp raised $600k, then $4mm, then 5mm, then $25mm, then $80mm (or something like that). And at the time of the sale to Yahoo!, he owned a very nice stake in the business even though he had raised well north of $100mm. He did that by keeping his rounds small in the early days and only scaling them when he had to and the valuations offered were much higher.

It's important to understand all of this if you are an entrepreneur. Understand what your investors are optimizing for. Many are optimizing for putting a lot of money out so they can get to their next fund and raise even more. It's a big money game of asset allocation. When you team up with VCs who are playing that game, you are playing that game. There are VCs out there who play a different game. If you want to play that different game, please knock on our door.

#VC & Technology

Comments (Archived):

  1. awaldstein

    You are a breath of really fresh (and straightforward) air at the beginning of what will be a busy and challenging business day.It’s a nice start.Thanks…

  2. csertoglu

    Perhaps eventually venture funding will cease to be a part of the PE/alternative investments asset class, and start to get funded by alternative pools of capital.

    1. fredwilson

      it could happen but not quickly

    2. bfeld

      Why would this matter?I’ve never personally focused on VC as an “asset class”. I know everyone likes to put things in buckets, but other than marketing / demand gen purposes, why is this important?

      1. csertoglu

        Our experience in the market is that most $ that flows into VC comes from asset managers that manage VERY large pools, including pension plans, sovereign wealth funds, etc. that prefer to write larger checks, providing an incentive for larger funds, that leads to the behavior fred points out.Smaller, specialized VC LPs, funds of funds, MFOs can resist the temptation. Plus, alternative pools can look at various factors beyond IRR, like developmental impact, smarter co-investment opportunities etc. that makes the behaviors fred mentions less attractive for VCs.i agree with fred that it will not happen quickly. But we have seen focused VC FoFs and I think that’s a good thing.

        1. pointsnfigures

          I see it as a selling tool to institutional investors. They bucket their money in bonds, stocks and alternative investments. VC is alternative, and if they are big enough, they ought to be assuming a little more volatility and risk by investing there.

  3. John Revay

    Excellent Post, I always enjoy these – talking about hypothetical examples (which i assume are real in some cases) $2M for 20%.The GP/LP stuff is always good as well, 80/20 and 2% is what I knew from my days working in the back office of a VC firm. It was simple back then – only issue might have been was there a claw back provision…..No it seems more complicated where GPs don’t receive distributions until capital is paid back to LPs, min guaranteed returns to LPs ( almost sounds like Preferred stock in some cases).

  4. hmmm

    $2mm for 20% is a worse deal than $5mm for 20%.That you can then raise the extra $3mm at a higher valuation later doesn’t change that.

    1. fredwilson

      that math is irrefutable. but it really depends on how you spend the $5mm. if you blow through the $5mm and don’t get much out of it, you will be worse off because now you are carrying a $25mm valuation and nobody will fund you at that price. its down round time. you are damaged goods. i have seen this so many times. way too many times. too many times to want to see it ever again.

      1. JamesHRH

        A down round is your best sales point, when talking to entrepreneurs.Harder to lay out the rationale for ‘screwing up your company in order to tidy up a fund (numbers-wise) in order to raise the next one’.Hard to have them listen to the fact that your customer is the LP – although you have a very streamlined story there (‘we get a good price for them, you can see it in our carry fees too’).The peril is more imminent in a down round – that’s the closer.

        1. pointsnfigures

          Corporate finance isn’t about the money, it’s a strategy.

      2. Vineeth Kariappa

        Had the same question. Thanks for your opinion. Still doesn’t make sense. Could you state some other reason for your bias towards a lower valuation at the start?3.6 mill carry, could you explain that , too?

        1. btrautsc

          If you take the $25M valuation (more imp than the money in this scenario) – you could* price yourself out of the market at the next round.I had a much more thorough explanation typed up then disqus somehow killed my comment. Key – if you build a high value 1 round, you have to have built significantly more value in the company or investor demand for the next raise.

          1. Vineeth Kariappa

            That is Fred’s “opinion”. I got that. If I had an option; 2 chocolates vs 5. I’d mostly take 5. I was asking him for a better justification, other than “taking a risk for your next round”.

          2. falicon

            The debate is 2 chocolates now, with high chance of 15 more tomorrow….OR…5 chocolates now, with a 50/50 chance of 4 tomorrow.If you’re just focused on the immediate needs/round then you are not looking at the whole chess game and will likely be checkmated very quickly (the market is a grandmaster level player after all).

          3. btrautsc

            exactly. reminds me of “bulls make money, bears make money, & pigs get slaughtered”.sure, if people are handing you as much cash as you want, you can take it – but realize that ‘with great power comes great responsibility’ – IF you want to raise another round in the future.

          4. Kasi Viswanathan Agilandam

            marshmallow experiment πŸ™‚

          5. Vineeth Kariappa

            every1 is already assuming with the first round, people will screw up. There is no other logic. It does not seem justified to undervalue efforts of people based on just 1 idea.

          6. falicon

            I would argue it’s actually the opposite…everyone is assuming that 1st round will be a hit, and because of that, a 2nd (and following) rounds will be required/likely.If, going in, you think with the 1st round there is a good chance that will be it (because it will be screwed up or because that is all that will ever be needed), *then* yes get as much as you can in round one.But if you believe the 1st round is just the start/fuel of hyper-growth and success (which I think is the idea behind most trying to raise funding), then you are better off being strategic about what is done in the 1st round so that you are on the best path for later moves.

          7. Vineeth Kariappa

            That made sense. What is “carry”?

          8. falicon

            dunno…out of my depth on the technical jargon of funding deals (I’m just a builder [and sometimes marketer])…to me ‘Cary’ is just an ex-girlfriend. πŸ˜‰

          9. Charlie Crystle

            @V_xklsv:disqus carry is the 20 in the 2/20 model: the amount the venture firm takes from the return on investment, typically 20%. So if a 1 million investment returns 8 million, the carry is 1.6 million.

          10. RichardF

            Carry is the % that the VC takes on the gain on the investment. That’s in addition to the management fee on the fund.

          11. ShanaC

            the market is a blind grandmaster

      3. takingpitches

        the point, for me at least, is clearer in later rounds like the 4sq discussion we had a couple of days ago.I am not sure why investors do not see the management fee/size of fund problem in VC. This is not classic PE like KKR or Blackstone.Force-feeding startups does not produce foie gras.

        1. James Ferguson @kWIQly

          +100 for this comment “Force-feeding startups does not produce foie gras.”

          1. fredwilson

            I will see you the +100 and raise you +100

          2. Matt A. Myers

            If Fred’s in, I’m all in..

        2. fredwilson

          Killer line. I plan to use it frequently. My colleague Nick reblogged it on tumblr

        3. PhilipSugar

          I love your line. We call it the “fake and bake”…You fake it and try and bake it. Never works.

      4. robchogo

        Seems to me the optimal thing to do then is to take the $5MM but budget conservatively so you have double the runway. You have more resources than if you had raised $2, but still got more capital for the same dilution. Practically impossible to do in practice, I suppose.

        1. PhilipSugar

          It is and here is why. You aren’t going to raise the $5mm if you say I really only need $1mm and 1 year to get to my milestones. If that is the case you are smart to raise $2mm and be conservative and know it might take twice the time and twice the money.Nope, you are going to say I am going to spend $3mm and it is going to get me there in six months!!!You are going to sign up for that plan when you raise that money. Think you are not??? That VC is going to say what could you do if you have two and a half times the money!! You signed up for it.Now guess what??? Just like if you think you can get two women pregnant and have a baby in 4.5 months (sorry gals there is no male anology here, bring it if you’ve got it).You are going to find that you now have nothing in 4.5 months and are in twice the shit in 9 months.

        2. fredwilson

          never seen it done

      5. PhilipSugar

        Absolute Truth!!! +1000I don’t care what people tell themselves. The more money you have in your pocket the more you spend. You will pay it back…that you need to remember.

      6. LE

        Makes sense because math and psychology are two very different concepts.Psychology and behavior always needs to be factored into strategy, negotiation and all decisions (business or otherwise).Many people don’t do that especially people who are numbers brained. Ask an accountant and he will say “yeah leasing/renting is better do that!”. Nope, it depends.Back in the day I remember “banking” sales and profit after a good year to get a head start on the next year and to keep trends going in the right direction. None of this is absolute of course depends on the circumstances and situation. Learned by doing not by reading or hearing also.”Damaged goods” is an important concept which shows how much emotion enters into decision making.

      7. Girish Mehta

        Fred, there are two ideas embedded within one sentence – (1) – you blow through the $5M and (2)- the risk of a subsequent down round. Now – IF you believed that, in a particular case, too much money at an early stage itself becomes a contributor to execution risk – not referring to the valuation or downround risk, but the amount of money itself (an example, high customer acquisition costs get built-in to a business based on a iffy Lifetime value assumptions – when you have money, you can find ways to spend and grow which may not be sustainable). If you cannot agree at $2M-20%, would you prefer a $2M investment for a lower stake or would you go slightly higher money for the same stake ? Going for a lower stake retains the potential risk for downround (IF you believed that your initial valuation was correct), but it reduces risk of the amount of money if you viewed that as an independent contributor, and it meets the founders on higher valuation. Is the % ownership target fixed/dominant for you ? (I can see the counterpoint from the founders standpoint might be to still go for the $5M and put away the excess somewhere if not needed immediately, but thats a different discussion). Thanks.

      8. ShanaC

        this is slow growth politics

      9. Charlie Crystle

        I’m so with you on this, except that the one risk that taking the $5 million eliminates is the risk, time away from the business, and cost of raising needed capital in the next round.

    2. Jason Kelly

      Yeah, the point Fred made about getting the $3M at a higher valuation later seems a little silly (maybe worth correcting?). What he says to you in response about down-rounds is at least logical.

    3. Richard

      Fred’s point is spot on, assuming 2mm is sufficient capital to validate your startup. One trivial example is the startup requires no additional funding. Another trivial example is the startup exits prior to a second round. A less trivial example results from pushing an up-round early (earlier vs the 5mm premoney valuation). Why? because of the Startups early success, the valuation and the demand for participation are shifted to a new trajectory.

    4. Kasi Viswanathan Agilandam


    5. Kasi Viswanathan Agilandam

      2 or 5 or 20 …take what you need to take the company to next level and can keep your share high.If you can go to profitable stage with the first round then take as much as you can ….but can’t see many companies going to IPO with just one round. It makes difference when u go for next round…That is where 5 will hurt badly…the next round…20 will just kill you (unless u can pocket some :-)).

  5. jason wright

    native advertising works

    1. fredwilson


    2. Vineeth Kariappa


      1. jason wright

        this is a peer-to-peer network of engaged users (and passive readers) that grew out of a blog.USV today displayed a rerun of its product advertising message to the natives (entrepreneurs, LPs, and other VCs). the message is that USV has its own product/ market fit, is sticking to it, and for the reasons the numbers describe.

        1. Vineeth Kariappa

          this is not advertising, its PR. Big diff.

          1. jason wright

            PR is big diff.

    3. William Mougayar

      About 50 years ago, David Ogilvy, the father of advertising said:”It has been found that the less an advertisement looks like an advertisement and the more it looks like an editorial, the more readers stop, look, and read.”He was describing native advertising.

      1. kidmercury

        great point. native advertising is not new and fun; it is old and boring. just like everything else.but of course it can still work well.

        1. jason wright

          you’re not old and boring.

          1. kidmercury

            i might be. i tend to favor the idea of reincarnation, which would suggest i could be very old, and that i’ve been here many times, doing the same old, boring thing. in that case i’d be old and boring, just like everything else.

          2. Girish Mehta

            Everything new is not fun, and everything old is not boring πŸ™‚

          3. kidmercury

            lol you are certainly correct, i just try to maintain a grumpy image πŸ™‚

          4. Girish Mehta

            Oh, i was commenting on ‘Native advertising is Old and Boring’ :-). Far be it from me to comment on The Kid.Just Kidding πŸ™‚ (pun intended).

      2. jason wright

        and 50 years later ‘editorial’ gives way to injected tweet and tumblog. they bring equivalence, but authenticity is still hard to get right.

      3. ShanaC

        at some point you’re tricking users

        1. William Mougayar

          Well…it depends on the consistency of the quality in the message and content. You can fool people once, twice but not many times.

        2. jason wright

          big corporation with a tumblog seems highly asymmetric to me. it’s almost a trick in itself, a masquerade. then comes the content trickery.

    4. Kasi Viswanathan Agilandam

      all the time.

    5. Aaron Klein

      Seriously…this made me laugh out loud.

    6. Matt A. Myers

      I LOL’d and have the biggest smile on my face right now

  6. John Revay

    “The $2mm buys us 20%”I need to go back to some of the archive posts – you did over a year a go…..I generally thought a company should go through say 4 rounds ( A>D) – and at the end give up 40%, 40% to EEs and 20% to founder (s).

    1. fredwilson

      yup. 20% is the upper limit of dilution you want to take on each round. if you dilute 20%, 20%, 20%, then you have diluted a total of 49%

  7. kidmercury

    it’s going to be interesting to see what happens to the VC industry as interest rates head higher. the moment all doom and gloomers have been waiting for appears to finally be here. i think it will be bullish for public equities but bearish for private ones, which would suggest greater difficulties in huge VC funds that blow pre-IPO bubbles.

    1. pointsnfigures

      not sure about that. Let’s assume a 1970’s redo. Interest rates skyrocket and inflation jumps because the Fed is asleep at the wheel on money supply. That’s not going to be good for cash equities. It’s also not going to be good for bondholders that are locked in. fresh money will go into bonds at higher rates. The only winners will be owners of commodities (because technically, they should keep pace with inflation) and people that invest in businesses that beat the rate of inflation. Those are startups.

      1. kidmercury

        it’ll be good for startups that can actually generate real profits and free cash flow. but how many of those are there? most of the startup valuations is driven by huge PE funds and flipping.i think public equities will benefit because money coming out of bonds will need to go somewhere. much of that money is in big funds that will find it easiest to invest in public stocks. as this is money coming out of bonds, i suspect it will be driven by a desire for security; as such, they will also appreciate the liquidity that public stocks offer. real estate could also benefit. granted, the benefit to public stocks and real estate will be countered by higher rates that make credit-driven buying more difficult. so the benefit may not do more than ward off a big collapse in those assets. personally i think luxury goods (i.e. fine art and precious metals) will be the biggest beneficiaries of a capital exodus out of the bond markets.

        1. pointsnfigures

          money coming out of bonds won’t jump to a bear equity market. Will go into some dividend paying stocks-but the money will go back into bonds, and roll. If you want to bet on a tradable asset class, bet on options. We are a lot more sophisticated in 2013 than we were in 1979. Options and OTC product volume will explode as everyone hedges risk.I disagree on real profits and FCF. For some startups those are great metrics, for others they detract from their mission. Who did better-investors in the market or Tumblr? Clearly, Tumblr had 0 FCF.

          1. kidmercury

            i just took a look at japan’s private equity market, as i think the US will mirror what has occurred in japan over the past 8 months (falling bonds, falling yen, rising nikkei). however new cash has continued to go to PE funds and public companies have used inflated share price to buy private equity stocks. so if we extrapolate that to the US, it looks like we might get bubble 3.0 in the valley! i wouldn’t bet on it but now that i looked at japan i can no longer have the same amount of confidence in my bearish comments on private equity.

  8. Jorge M. Torres

    Today’s post does a great job of highlighting the problems with raising large funds. It creates all sorts of perverse incentives for founders and investors, like favoring short-term thinking over building long-term value and scaling rapidly over growing sustainably. For a large fund, a $100 million trade sale is a disaster. I agree with Fred. Founders need to know this stuff.

    1. bfeld

      This underscores the importance of fit, and understanding what the motivation of the investor is.I’ve heard over and over again from VCs since 1994 when I started investing as an angel some version of “we have to have enough ownership to make this worth our time.” When all VC funds are the same size (or in a similar band), then this is simply a positioning statement on valuation (e.g. in 1994, a huge VC fund was $200m and many were < $100m). But when VC funds range from $50m to $3b, this becomes a strategy point for VCs.Once it becomes strategy, is segments the firms, how they operate, and what they are interested in investing in. Of course, large firms can easily say “we do seed investments also – we have a seed program where we write small checks. True, but the rise (and fall) of the VC party round shows how that plays out – small checks don’t translate into engagement in many cases.

      1. William Mougayar

        Exactly.Big funds shouldn’t be allowed to enter seed/A rounds. That would force some level-headedness into deals. Their big hammer approach can distort reality.

        1. bfeld

          “Shouldn’t be allowed” – I think they should be able to do whatever they want to do. Entrepreneurs should filter based on what their motivations. So – if you believe big funds shouldn’t be part of your seed round, unless they are really committed to your company, insist that the VC take a board seat when they make a seed investment. That’s separate out the people tossing money around from those who are serious about the seed investment.

  9. Steven Cohn

    We entrepreneurs hear VCs constantly complain about this, but facing competition that uses price to differentiate is nothing new to us. Any operator faces that every day. The answer isn’t to pretend that price doesn’t matter. Frankly this quote doesn’t make sense, “The answer is you can get the other $3mm later at an even higher price.” Why would I want to raise that extra $3 mil later? I still end up with more dilution in your scenario. Your firm has a better response to this competitive pressure than most…that is you add value beyond just cash. That’s the right answer! Yet so few VCs talk about that. There are a few firms who do provide value beyond cash. And I think the competitive price pressure is going to force others to focus on this more. So from an entrepreneur’s perspective, it is great that this price war is happening. We have every incentive to make VCs work harder for us.

    1. bfeld

      I think the value provided is implicit in Fred’s point of view. If you, as the entrepreneur, think one VC provides more value than the other, I’d assert that should be your highest order sort. If you have the option of multiple funding scenarios, price matters, but fit / value with the investor matters even more over the long term.I also don’t think this is a “VC complaint” at least not from Fred, or from me. We run into plenty of situations where an entrepreneur is simply focused on price maximization in their financing. That’s cool – and they may be massively successful – but that’s likely not the investment for us as we care a lot about bi-directional fit.

      1. John Revay

        Nice Comment Brad! “but fit / value with the investor matters even more over the long term.”

      2. Steven Cohn

        I don’t think there is much of a gap between our POVs. Which is not surprising since your firm also focuses on value beyond cash. But I doubt you would disagree that few firms actually do this. And those are typically the ones chirping the loudest about price pressures IMO

        1. bfeld

          Anyone who is whining (I assume chirping means whining – at least that’s how I interpret it) about price pressure is an idiot. I don’t think Fred is whining about it. He’s saying “here’s how we do it – and why.” That’s different.I agree with you – lots of VCs whine about it. And that should be a clear negative signal to the entrepreneur.I think whining is very different than having a philosophical perspective and articulating a point of view. And then being consistent about it over a long period of time.

          1. Steven Cohn

            I agree, which is why I said in my initial comment..”Your firm [AVC] has a better response to this competitive pressure than most…that is you add value beyond just cash. That’s the right answer! Yet so few VCs talk about that.” Brad – I would include your firm in the few who have that consistent perspective too. But it is not as simple as big funds (that pay higher valuation) don’t provide value or have a great fit. There are great VCs in many large firms.My overall point is that VC price competition is good for the entrepreneur. It makes the VCs work harder to differentiate. It makes the industry evolve. And the great ones don’t feel the pain of this issue as much (as you point out with your fund and with USV). But the other funds (which obviously is a large majority of the industry) do feel this pressure to differentiate. And that is great in my view!

          2. bfeld

            I completely, 100%, agree!

          3. bfeld

            Great post – thx for taking the time to write it. Just commented on it.

      3. ShanaC

        how do you figure out bi-directional fit?

        1. bfeld

          Spend a lot of time together.

    2. JLM

      .The harnessing of competitive forces for funding whether in the sense of the number of sources or the price of the money itself is a simple business phenomenon.And, you, entrepreneur — you are in BUSINESS.Harness the power of competition at every turn and make the best deal for yourself.Money is fickle and what it thinks today will change quickly.Never get mad at or fall in love with money, it will change its mind.Always use the power of the marketplace and competition to drive a fair deal but the best deal for yourself. Don’t be cocky or obnoxious, just be a bit shrewd.Next month VC Aid in Omaha? Not bloody likely. VCs can take care of themselves.JLM.

    3. fredwilson

      All true. But the price war has costs to the entrepreneur that aren’t obvious until they are

      1. Jeffrey Hartmann

        I think this is why it is so very important to be strategic about how much you raise, who you raise from, and knowing up front what your goals for the money are exactly. Others have brought it up that the first round money is the most expensive money you will ever raise. This is definitely a multivariate optimization problem on long term value, and just optimizing one aspect will not maximize the area under the value objective function. If you want to maximize your chances to make it to the pay window, you have to optimize for advice, value add, connections, price, deal structure, and having the right amount of money to show significant progress, among many other things. Just optimizing for price will tend to decrease some or all of the other variables.Another thing that most people don’t take into account is that the existing investors have to invest a pro rata portion at each round of financing if they want to maintain their ownership stake. So you might have them paying 2 mm now, but over time to keep their 20% they might spend much more over all the funding rounds. So the guy who got 5mm at first may still be worse off, since the valuation differences can when you prove you can make huge progress on a smaller amount of capital can end up being considerable. The VC is paying 2mm now, but might have to spend much more then that 3mm delta to keep ahold of their 20% over time depending on where the long term valuation goes. Say your first round is 2mm on a 10mm valuation, and the next round of financing you give up an additional 10% of the company for 10mm at a 100mm valuation. The guy who owns the first 20% will get diluted by 2% so he/she has to grab 20% of the next round to maintain their 20%. If the numbers end up being larger because you optimized for long term success, not just winning the day it can definitely totally make sense to not take the 5mm. A couple more rounds like that, and the long term payout from the VC for that 20% could end up being substantially higher. Like Chess financing has be played several moves ahead. Optimize for the checkmate, not how many pawns you can take now. You might leave yourself in a much more vulnerable position.Also perhaps you don’t want to just optimize for monetary value, but you have other goals in mind. You have to optimize for them as well. If the VC who is offering 2mm shares your world view and vision for the company it can make a huge difference over time.

    4. William Mougayar

      VC’s advance funds so the entrepreneur can grow the company. Everything else is secondary to that factor.

  10. JJ Donovan

    Proof that not all VC firms are created the same. This post drives home the thought that professional services and products can adhere to the SOQNOP theory.

    1. bfeld

      I believe VCs are Dungeons and Dragons characters.See…It goes deeper than just VC firms are different. The individual partners are different, and the firm is a collection of partners.Understanding both overlays is critical.

  11. OurielOhayon

    Fred, did you consider secondary? if a founder take money off the table?

    1. Vineeth Kariappa

      If a founder wants to sell his equity in the first round, don think any sane person would back him.

      1. bfeld

        While true, we are seeing founders who think it’s reasonable to take money off the table in an early round, well before any demonstrable progress. This has never made sense to me nor will it ever make sense to me.Once the company has revenue, is scaling quickly, and clearly is on a success path, a secondary is fine, but even then I want the entrepreneur to be equity greedy. Taking enough off the table to sleep better at night is fine, but getting rich in an early round – well before anyone can assert that success is happening, is just bizarre. And a huge negative signal on the future potential of the business.

        1. Albert Hartman

          Everything looks up and to the right at the beginning. I know several entrepreneurs who were wise to take a meaningful gain early on via a secondary. Things changed eventually, they fell out of favor with their investors even though the business was still growing, the business needed a big cash infusion during a bad investment period and crushed their holdings. The money they got out early was the only money they ever got. You have to fairly align the investor and entrepreneurs interests.

          1. bfeld

            I’m assuming there is no real business yet, just future optimism. In this case, it makes no sense at all to me.

    2. fredwilson

      We do that frequently in the later stages via our Opportunity Fund

  12. pointsnfigures

    There are two sales lines in your post that mean a lot. I try to follow the same principles because I think it says a lot about the culture of the firm. First, “We are very much focused on what is in the best interest of the entrepreneur”–>brings you better deal flow, and better outcomes. If you focus on the numbers and the money, your LP’s are not going to make as much. You have to focus on the entrepreneur-they are the engine that drives you across the finish line. Second, you have set your fund up so that you can fight for LP’s. Why should LP’s pay for higher valuations? Discipline is key. Statistically, what’s the probability that Deal A will win vs Deal B? Probably not a big difference.

    1. Tom Labus

      Many give that concept lip service only.I’m sure Fred’s route is in a very small minority.These are like routes to Everest’s summit. You want to summit but you also want to make sure you make it back down alive

  13. William Mougayar

    This means you have have to work a bit harder to get these deals.Throwing money is easier than talking sense. And protecting yourself against down turns is a good strategy. It’s like insurance. That’s why not everybody buys that.I bet this approach also self-qualifies the entrepreneurs you want to work with. The ones that get lured by higher valuations may not be the right fit for your strategy.Frugality works both ways.

    1. bfeld

      Yup – an entrepreneur who is just maximizing price is less interesting to me to work with than an entrepreneur who is focused on getting a fair / good price but is maximizing “collecting people” (including investors) who can help her win.

      1. JLM

        .Not to piss on the campfire but isn’t your definition of a “fair/good price” always a better deal for the VC?Surprised at that, really. Not.JLM.

        1. bfeld

          Piss away!It’s all perspective. I define a fair/good price. The entrepreneur gets to define a fair/good price. Presumably we are both playing to create a lot more value. If our prices are close, we have a deal. If we don’t, we don’t.

          1. JLM

            .Exactamente — one gets what one negotiates rather than what is either “fair” or “good”.Nobody is going to force a VC to reach for her checkbook unless they think the deal is in her best interest.The notion that everyone has to feel good is just so much baloney.Everyone acts like a gentleman, treats each other with dignity and respect, negotiates in an adult manner and cuts a deal that works for both of them.It’s just business.JLM.

          2. bfeld

            “The notion that everyone has to feel good is just so much baloney.” – Everything else you say makes sense but I don’t understand this. I’ve never made a first investment in a company that I haven’t felt good about when I made it. And I don’t think I’ve ever been involved in an investment where the entrepreneur didn’t feel good when I first invested. In the upside case, this then holds all the way through.When things don’t go as planned, I’m still focused on a “fair” price (e.g. I don’t gratuitously price agressive down rounds and wipe out entrepreneurs and other investors just because ‘I can'” – I recognize that the entrepreneurs / managers are running the company (not me) and they need to have future upside. But there have been plenty of these future rounds where not everyone felt good, although I still focus on being fair.

          3. JLM

            .If you reflect upon your words, you answered your own question.You act exclusively in your own best interest including your comment about the necessity to provide an ongoing financial incentive for the entrepreneur/manager in a struggling enterprise.That is just good business logic not some higher or transcendental emotion. It is business.Money moves when it makes sense not when it “feels good”.JLM.

          4. bfeld

            I suppose. But I don’t disconnect from the emotion of it and my decisions are not driven off a spreadsheet.

          5. JLM

            .Isn’t a spreadsheet really only one aspect of one’s due diligence? On most anything?Doesn’t one examine and focus on the character of the entrepreneur, the quality of his vision, her experience?These are qualitative aspects of due diligence in the continuum of jockey, horse, course.At the end of the day, they can certainly be reduced to a mathematical equation or matrix with weighted values and thus arriving at some purely quantitative model. Not suggesting that is the right approach but simply that any complex decision can, in fact, be modeled.I am a huge believer in instinct — gut reaction but would also study the model and grade the entire opportunity in its entirety.For me personally over a 35 year career, I have found my instincts are more powerful and accurate as the level of my tuition has increased. Wisdom from experience perhaps.Again, emotion and feel good and confidence interval may be the result of this process — but it is not an input into the process.JLM.

          6. bfeld

            I guess we’ll disagree on this. I think how you feel is an important part of the qualitative analysis of any VC / early stage investment.

          7. JLM

            .I think the difference may be that I see the notion of “feel” as being the result of completing one’s due diligence rather than a discrete input into the due diligence.Different strokes….JLM.

          8. LE

            “I guess we’ll disagree on this.”One thing I have always found is that you can’t graft one person’s way of thinking on someone else when it comes to deal making.A good example of this would be trying to get someone to execute a strategy that I feel totally comfortable with that someone else does not. Because it’s nuance you can’t describe every possible play by play which inevitably happens adjustments will need to be made.Doesn’t allow for minute changes based on new or changing inputs.For example, if you are familiar with NYC and get lost you can figure it out and find your way. But someone not familiar can’t do that. And no amount of advance instructions or words will allow them to do so.

          9. LE

            I like that.What I always say is that you decide you want something. Then, within certain parameters (obviously), you try and get the best price.But don’t make a decision by the price. (Unless of course you are buying or selling a commodity or in some other limited cases.)To many times I’ve seen people do things or make financial decisions only if “I get it at $x price”.Here’s a small illustration that everyone can probably relate to.You go to buy a car and decide to walk because you can’t get $500 more (or pick your number whatever) off the asking price.If the decision is right (car model, color, dealer) then the $500 is not relevant. If the decision is wrong then the money is not relevant. Getting a bit more off the price won’t make it right.Same applies to buying real estate or a host of other things. [1]I recently saw a friend (and someone I helped) walk from a deal on Shark Tank because they were dicking around trying to get a smaller shark percentage of their company (the 2nd time they were in the tank). The first time they got funded and totally attributed the 5 million in sales they are doing this year (from 100k before appearance on TV) to the shark tank. Yet they lost deal two over percentages trying to appear to be skillful negotiators. (They did get funded by one less desirable shark but backed out when they saw the contract terms).A classic case of “hogs get slaughtered, pigs get fat”.[1] Marketers of course do this in reverse by playing on trying to get you to buy things that you don’t need by presenting a good deal. This is done just about everywhere over all socio economic groups. It’s baked into human nature to respond to this type of trigger and take advantage of an opportunity (or rationalize spending for something you don’t need).

  14. jonathan hegranes

    Wonder what happened yesterday, or recently to spur this post? Or has it been on Fred’s mind for a while…

    1. bfeld

      I think this is always on Fred’s mind. He and I talk about it periodically.He’s talking at a conference in the bay area (Pre-Money) that is Dave McClure (500 Startups) LP conference.Rather than pick a dull pre-canned marketing topic, I think Fred is planning on having some fun stirring it up.

      1. kidmercury

        manufacturing beefs is always a strategy i recommend

        1. bfeld

          As a vegetarian, I especially enjoy tofurky.

          1. kidmercury

            you’re a vegetarian? me too! well, sorta. i have sushi about once a week. hooray for minimal meat eating!

          2. bfeld

            Sushi is about the only meat I eat. So I guess I’m a veggiesushiterian.

          3. Jeffrey Hartmann

            I was a veggiesushiterian for many years as well. I have much love for the sushi orgy, and couldn’t give it up when I stopped eating other meats back in 2000. I’m back to being a carnivore these days though. Being married to a Brazilian woman it is hard not to love Churrasco (Brazilian BBQ).

          4. ShanaC


          5. jason wright

            have you tried tempora?

          6. ShanaC

            you’d love my cofounder, as he too is a vegetarian

      2. jonathan hegranes

        Good point… You mostly hear this from VCs and seasoned entrepreneurs, but in general a mistake most often learned from experience.

      3. ShanaC

        ha. No news sometimes creates these sitautions

  15. William Mougayar

    Also, if things don’t go as planned for the startup, the larger the check was, the less sympathy you may get for a re-load. So the fall is harder on the startup from a higher valuation. And the liquidation preferences suddenly eat up a lot more of your equity.But if things go well, then it’s a moot subject. So why risk it? Take the sensible approach.

  16. JLM

    .Great post and a fabulous discussion.I have spent my career as a consumer of funding — over $1B in my career and in a number of different industries. I have started or turned around 5 different companies. I have made it to the pay window a few times and I have gotten my dick knocked into the dirt an equal number of timesI have survived both. I have learned from both.The world is divided between those who provide funding and those who consume funding. Funding can be either debt or equity or a combination but at the end of the day, it is all just money and it has a price tag on it.Never get mad at the money, it will change its mind. Never fall in love with the money changer, it is not his money. He is a money pimp — in the nicest possible way, mind you.I have the utmost respect for Fred Wilson and I think he is an outlier in a very tough business. I think he is an honorable man and he speaks the truth. If Fred had a bit tougher set of terms, I personally would do business with him because I think he is authentic and genuine and I have a very finely crafted bullshit meter.But, by practice, he speaks from the perspective of one providing money. He is true to his clan, his tribe.As a consumer of money and a guy with a well worn tin cup, here are some observations for which I have paid a bit of tuition.Companies fail when they run out of money regardless of how good the vision or founder. Money is only as important as air or water or fire. Companies do not fail because there was a bit of to-ing and fro-ing over valuation. Get a lot of money when you can.The David Krafts of the world are one in a million chances, you are not. Your deal is not Instagram. Sorry. But, you are still damn good and you can get filthy rich.The provision of money can, at times, be a competitive endeavor. Harness the power of competition to get the best deal possible. In life you don’t get what you deserve, you get what you negotiate.Learn how to negotiate in a skillful and calm manner and get the best deal for you. Take your time. Fred Wilson can take care of himself, you take care of yourself.Don’t get cute when pricing or valuing or taking money. Get as much as you can use and a bit more regardless of the price. You don’t set the price, the marketplace sets the price.Everything costs twice as much and takes twice as long as you ever think. Know this and reflect upon this when you are accessing capital. Get enough and then some regardless of the dilution.If they are throwing dirt on your casket, the headstone is not going to say — “Hell, he didn’t get diluted much.”The most important decision you will ever make is the people involved. Underwrite the people as much as the deal. Do not take a chance on the people. This is Fred Wilson’s great advantage. He IS the guy who you see on this blog.Truth — when that asshole VC shows up in the BMW with a splash of mousse in his hair, can’t get his smartphone out of his hand and spends all his time telling you what a great guy he is — he’s still an asshole regardless of what words come out of his mouth. Find out how he unwound an unsuccessful deal and you will know his character.Deal with a bit older VC if you can — they have stared down the barrel of both triumph and disaster personally and professionally and they have a bit of character. You don’t know your character when you are 28 years old. You haven’t had enough time to develop or reveal it yet.Who really cares what the pricing is going to be if the funding will get you to the pay window? You run out of money and you are screwed. You get to the pay window once, twice, thrice and then you fund yourself some day. But get to the damn pay window. A few million either way is not going to make a bit of difference in a 40-year business career.The number of folks who provide money and “something else” is a very, very, very small number. Don’t believe most of the “we have a value add” baloney unless you can speak to a founder who has gone to the pay window riding on the crest of that wave.Remember they also teach marketing at HBS and Wharton — not just finance. Consider the notion that they are bullshitting you.Good luck and God speed. Get the money and thrive.JLM.

    1. takingpitches

      Wisdom from having worn through many sets of tires.#BRCTruth

      1. JLM

        .Our secret. Haha.JLM/BRCwww.themusingsofthebigredca….

    2. William Mougayar

      “Do not take a chance on the people… He IS the guy who you see on this blog.”I was reflecting in a similar way to @bfeld:disqus on his blog this morning. Basically, VC’s who blog reveal so much about themselves that you almost already half know them. That’s a good process of self-matching.The alternative is you end-up taking chances on people, as they reveal themselves over time, and sometimes not always in so many good ways.

      1. JLM

        .Of course, content is king.Sometimes folks reveal something that is unattractive and dissuades you from wanting to do business with them, no?Like the idiot who remains mysteriously silent and unfathomable and then reveals his idiocy by speaking.Better to be silent and perhaps thought an idiot than to speak and remove all doubt?JLM.

        1. William Mougayar

          It’s more than content, JLM. By writing a blog, you touch people. You give them insight and that’s more powerful than anything. Their legacy is that, in addition to the deals they make.When you write your blog, you’re touching people too. And I don’t mean it in a feely way. I mean people take action as you provoke meaningful thoughts for them.

          1. JLM

            .I agree more with you than you do with yourself.I was using the term “content” to subsume all that you have said. You just said it better.JLM.

      2. LE

        “Basically, VC’s who blog reveal”Various studies (sorry no links ..) and psychological principles ( Cialdini “consistency” for example) [1] state that people have a strong desire to remain consistent with things that they say (also fits in with priming principle as well).From wikipedia about Cialdini and consistency:Commitment and Consistency – If people commit, orally or in writing, to an idea or goal, they are more likely to honor that commitment because of establishing that idea or goal as being congruent with their self-image. Even if the original incentive or motivation is removed after they have already agreed, they will continue to honor the agreement. Cialdini notes Chinese brainwashing on American prisoners of war to rewrite their self-image and gain automatic unenforced complianceI don’t normally quote academic things but when I feel that based upon my experience they are correct I do (otherwise it’s to easy to simply find something to support a point with the net). Cialdini basically reverse engineered many of his principles by studying what people in everyday life do (something that I happen to do as well just this morning I was fascinated by the pest control salesman’s techniques.).[1]

        1. Matt A. Myers

          It becomes their guiding / leading metric — it’s why positive mantras work, why positive thinking works; It’s why suggestive phrasing can work..You will give Matt A. Myers $100,000 if you like his ideas enough when he comes to talk to you about it.

      3. Girish Mehta

        Great point on the self-matching, thanks.

      4. Matt A. Myers

        VCs who blog selectively craft what they want to say – it’s their marketing platform. Fred of course mentioned this in his interview with Sarah Lacy.”Consider the notion that they are bullshitting you.” could still hold true even here – though I think Fred is honest, respectable, and plays his hand well and fairly.They’re also teaching which builds trust, and makes them useful – and shows that they know what they’re talking about.The part I have a tough time with is the ‘unknown’ of the bigger money. I suppose you could assume there will be more pressure on you if you’re not performing as well as hoped, as there will be more pressure on a VC who might only get a 3x return vs. an 8x return such as in Fred’s example.The equity difference when aiming for a $1 billion valuation, whether a founder gets $100 million or $300 million (or more) doesn’t make a huge difference — although it sort of does if you want to build a company like Tesla afterward, where there are a lot more higher initial capital R&D demands … but that’s a trouble and a problem to solve for another day.

    3. ShanaC

      the best marketing I have heard of – being genuinely nice and upfront. Honesty is almost always the best policy

    4. fredwilson

      Heed these words

    5. Mark Organ

      JLM speaks the truth. Amen, my tin cup brother-in-arms.

  17. bfeld

    Here’s one. VC says “I don’t care what your premoney is, I just want to own 20% of the company.”React.

    1. Brian G

      Great…let’s go with a $500mm pre-money then.Reminds me of an old joke: Old man meets attractive young woman at a bar and tells her he is old, lonely, and rich. She seems sweet and he would like to share her company in exchange for $1mm. She says he seems nice and would do it. He then says “ok how about $1 dollar then.” She responds “what do you think I am.” He replies, “We have already determined what you are…now we are negotiating.”

      1. bfeld


    2. Jeffrey Hartmann

      Depends on the situation obviously, but say if you have a strong team and 1 year runway can make a huge difference I might suggest something like the below:’Okay VC, well we are not ready to give up 20% just yet so lets ramp up to this, you commit 1 years funding for the existing team plus enough to grow the team by say 1-2 headcount in exchange for 10% in a seed round and then we will sell you an additional 10% at the Series A for whatever is market price at that point. If you want the 20% now, we would have to ask for considerably more up front because we know we have something very special here.’Then you negotiate, then you execute, then you both win.

    3. ShanaC

      why? i mean, you start to wonder what is really in it for them(you asked)

      1. bfeld

        Presumably the VC just wants to own a 20% stake. That’s an irrational perspective from my point of view, but a lot of firms have that perspective.

  18. Frank Luciano

    Let’s say the company goes with the lower raise/valuation only to discover (due to quicker than expected growth, an unexpected but beneficial opportunity, etc.) that they could use that additional cash. Wouldn’t hitting the street twice in relatively short order be tough and look as bad, if not worse, than a down round further down the line? Would think it’d make more sense to raise more initially and actually use (or better yet, “not use”) the cash wisely.

    1. bfeld

      I’ve faced this multiple times. It’s a joyous situation. We simply do another financing at a meaningful step up. Sometimes it’s an inside round, sometimes it’s led by an outsider.Zynga is a great example of this. Fred and I led the first round. 30-ish days later Avalon led the next round at a 2x valuation. A few months later KP led the next round at a 4x valuation to Avalon’s round. This increase wasn’t based on hype – the company was generating cash and it was more than doubling each month.

      1. ShanaC

        that is a good situation

  19. Aaron Klein

    It’s amazing to me how much things have changed.A 90s consultant to a number of firms on Sand Hill Road told me “your job as CEO is to raise the highest amount of money possible at the highest valuation possible.”Perhaps that was once true, I don’t know. But as you point out, that math can screw entrepreneurs and early angels.

    1. kidmercury

      i still that makes a lot of sense if you have the discipline to not spend the cash unnecessarily (which is extremely difficult as things tend to look like a bargain when you have more money).

      1. Aaron Klein

        What changed my thinking was the idea that “this is the most expensive money we’ll ever raise.”That makes you want to raise less, not more.

        1. jason wright

          be lean. you learn more that way. being scrappy is performance art.

          1. Aaron Klein

            Yep. That’s definitely been true with us.The hard part is figuring out the inflection point when you need to scale. Based on what folks have said, Tumblr probably delayed the transition to scale a little too long.But there are far worse sins. πŸ™‚

          2. Kasi Viswanathan Agilandam

            yep….the inflection point….that is the catch….that is why and where VC’s like serial entrepreneurs. It is an art and not science.Don’t bother much …. we will learn it ourway: -)

    2. Tom Labus

      Cash can also keep you alive to fight another day too

  20. Kasi Viswanathan Agilandam

    come to USV- for long tail.Go elsewhere other.

  21. andrewparker

    I agree with everything here emphatically, except this paragraph:”We are also very much focused on what is in the best interest of the entrepreneur. You might ask “how can taking $2mm for 20% be better than taking $5mm for 20%?” and you’d be right asking that question. The answer is you can get the other $3mm later at an even higher price. That has been the history of many of our investments.”Logically, the valuation on the next $3mm would have to be infinity to be equivalently beneficial to the entrepreneur. So, this is the wrong way to make this argument. I still agree with the conclusion that entrepreneurs would benefit later in the life of the company by raising capital at lower prices earlier, but the right argument in my mind is one of downside protection:If the entrepreneur raises $5mm for 20% instead of $2mm for 20%, the post money valuation on the deal might be so high that the company fails to grow into its valuation and is incapable of raising capital in the future. To avoid this problem, raise less at a lower price in order to make it easier to grow into your future valuation.

    1. falicon

      @aaronklein:disqus mentioned the quote “this is the most expensive money we’ll ever raise.” which I think sums it up perfectly…and I think actually holds true through each/any raise as to why you want to be strategic with the numbers and not just out to get them as high as possible…

    2. ShanaC

      this is a strange question: exactly how scared one should be about the downside to think that way

  22. Seth Lieberman

    Fred- Saying “great post” is like calling your talk radio station and asking “how you doing” as your first comment, but great post.Implicit assumptions:1. Capital is always available (it is not).2. A smaller amount of money will be sufficient to gain traction for another (higher) round. Capital efficient/Lean or not, some business simply take more money to get off the ground (eg B2B).3. Raising money is easy and not a distraction for the CEO and the business (I know you don’t think this).Sometimes it is better to raise more, take the dilution and the piece of mind and get back to work- you may end up with a bigger exit for all.

  23. The New VC

    Lets say you do believe you can grow into and past the post- money valuation. Wouldn’t it then make sense to optimize your seed round which can often be your most dilutive round of funding?Also you may be an exception Fred but a number of CEOs I’ve talked to privately confide that their investors don’t add as much value as they like to think. No one will say this publicly as they are married to their current investors till an exit. In this case taking dumb money with little control coupled with a stellar advisory board (composed of operators) may let the entrepreneur pick the best of both worlds. It would also minimize their dilution.

  24. Tom Labus

    Did Karp know about the smaller round route or was it luck?

    1. Kasi Viswanathan Agilandam

      look at who put the first round …The teacher πŸ™‚

  25. reece

    our interns were asking about how we raised money here at Shelby.TVmy takeaways for them was cribbed from AVC, etc…build real relationships and a good reputation among other good people. don’t optimize on price, just work for fair deals and create your own value. too much money, hype, high valuation too soon, and you create issues for yourselfmo’ money, mo’ problems man…

    1. Kasi Viswanathan Agilandam

      agree with with you mo’

    2. ShanaC

      not always – sometimes more money resolves certain things

  26. Jeff Hasselman

    Fred – Sage advice. Thank you for paying it forward by educating others on the venture ecosystem. 1. Today it is much less capital intensive to prove your concept. Disruption to the traditional VC model is upon us as the agency model has rooted itself. Not all money is the same.2. By taking fewer dollars today and reaching certain milestones, it provides significant investor optionality in the future. This optionality again at its core foundation of proper fit and that not all money is the same. Could not agree more that taking more equity money (when not needed) at a higher valuation ratchets up risk of limiting future outside investor pool at the ctitical juncture when you seek to scale.

  27. jason wright

    “For accredited & active investors only, PreMoney is a 1-day conference about the most disruptive models, platforms, and strategies for modernizing venture capital.”reads as deeply incestuous.

  28. Jim Patterson

    I lean on the smaller side as Fred outlines in this column. Not because of the “you can raise more at a higher round” argument, but because many (not all) entrepreneurs have uncertainty about uses of finds (timing, people, etc.). In fact, many (not all) fail to understand that raising a round earns you the right to raise the next round – it’s not a right to run a business to cash flow positive. I am amazed at how many entrepreneurs fail to clearly define and understand the next milestone.

    1. William Mougayar

      Well said. You don’t do a home run with a Series A, although there are very rare exceptions.

      1. Jim Patterson

        Thanks. One piece of advice I recently gave to an entrepreneur had bootstrapped prior to the round raise was “think ahead to the maximum amount you will be able to raise in the next (B) round to retain control of the company.” In this company’s case, it was likely $8-10 million. I am fairly new to Fred’s writings (but know Brad Feld’s quite well and they are usually aligned) – is this in line with advice he has given in the past?

  29. mikenolan99

    Just today I talked with an entrepreneur developing a SAS in an educational space. His questioned focused on how to set up his first LLC and be prepared for funding rounds.As usual, I recommend reading past articles on for a look at how investors think. Fred’s post today could not have come at a better time.Fred – perhaps you could directly address early formation of LLCs by companies to make it easier to interact with investors. Tips for corporate structure, units vs. member interests, etc.

  30. msheeley

    Which investor help you hire top talent? Which investor will allow you to run your business the way it should? Which investor will use their network when you need it? Which investor will help you close a future round of funding? Which investor sits on boards of companies you want to learn from?The dilution math isn’t the answer here. Unless you already have all the answers, the extra $3 million will be worthless.

  31. Govind Kabra

    I still dont get it.. you can raise $3MM later at higher price, but you will still give some equity at that point (5%? 10%?). In total, you would give more than 20% for the same $5MM.Of course, there’s all the other factors of what value either of the firms bring to the table, but all things being equal, dont understand the logic of taking $3MM at 20% instead of $5MM at 20%.

    1. Patrick Hemminger

      IMHO, the idea there is too raise enough cash runway to get you to the next milestone/benchmark, somewhere in the neighborhood of 12-18 months of burn. Once at that point, hopefully you have built enough Goodwill in the enterprise to demand a better valuation for the $3MM round, thus preserving more equity for the entrepreneur’s and the enterprise. If you have not built enough Goodwill to demand the increased valuation, then you probably need to take a look at your team/product/service/widget and iterate.

    2. kidmercury

      if you raise at too high of a valuation, you’ll probably throw off your whole cost structure. you’ll scale too much, you’ll spend too much, then the market will realize this and you’ll need to raise even more — and probably at a lower valuation. raising a ton is great if you spend it prudently, but this is extremely difficult, as the best enforcer of prudent spending is a lack of excess money.if you are confident valuations are excessively high and you are confident you can be as frugal as is optimal (without being too frugal) then you may benefit from taking a high valuation. the more uncertain you are about this stuff the more gradual pace is advantageous. for most folks in most situations a gradual pace is probably the safer bet.

    3. Jeffrey Hartmann

      Not all deals are 100% equal. Say the 5mm requires that the investor have 2x Participating Preferred rights on their stock. For comparison lets also say the 2mm valuation is a 1x non participating preferred deal. In the event of the liquidation of the company even if everything else is the same in the future as far as valuations (it probably will be lower valuations in the future if you take 5mm, but not necessarily) the 5mm deal likely is going to having different terms and the terms can matter and you are worse off. In the case I outlined above the 5mm VC will get 10mm dollars off the top of the deal and then things get split pro rata as if converted to common. The non participating preferred gets their money back or their pro rata share as if converted to common, whichever is higher. There are plenty of scenarios where the 5mm is a bad deal. You can’t just look at price. I suggest everyone read Venture Deals, an excellent book on this subject by @bfeld and @jasonmendelson. If you end up needing funding, definitely do your research so you know how to better evaluate deals. Fundraising is a lot like Chess, the best looking first move might not end up being the best long term one. Think about your goals and your future needs before you jump on a deal. As with everything in your business, careful consideration is important and can matter a lot when it comes to your end result.Also the terms on the first round of financing also set the stage for every other round. New investors usually want what the last guy got + more. Definitely there are much more variables in the game then just simple price.I wrote a response a little earlier in the thread regarding how valuation of future rounds, dilution and pro rata investment can end up making a difference in the long term as well. If your next round is going to be a lower valuation then it would have been, the investors long term commitment for holding onto that 20% might indeed end up being higher over time. Investors love it when founders can make magic with less money, it shows they are savvy, and while not guaranteed at all it definitely increases your likelihood of a larger round in the future if you execute well with less resources to start.

  32. James Ferguson @kWIQly

    Bitcoin volatility is an interesting concept.There is an absolute limit of a scarce valuable resource.The scarcity does not change. The intrinsic value does not change (it is what it is) an enabler.The only thing that changes are the perceptions of its future value.Therefore it is not that Bitcoin is volatile, but that our evaluation of the impact relative to monies we currently use that are volatile.Fears that it can be destroyed are fanciful. Fears that it (the idea embodied in the protocol) can be regulated by any nation state are fanciful.The only legitimate fear is whether a private individual will be allowed to participate by the nation state (to which he is if law-abiding subject).If it proves to provide friction-free low cost transactions on a global scale (as is at least possible), then arbitrage demands that the value is represented in terms of relative value to other commodities.So if a market can exist (we know that to be the case) and is efficient (yes) and if it cannot be quashed (true) the value as at least a price-pegging mechanism of choice must emerge.The common medium of exchange as a price pegging mechanism is the intrinsic value of money (any money). Bitcoin must succeed perhaps to be eventually superceded by an even more elegant solution.

  33. Ivan Kirigin

    Have you considered having management fees based on your operational costs, not a percentage of the fund? It seems silly to try to get lower fund sizes in part because other firms enjoy the percentage fees on larger and larger funds.Also, you bring up returns. I have asked this a few times elsewhere, but why don’t we see more transparency on returns? Founders should care about it to measure your judgement and value-add, right? The average for the industry might be really bad, but that leaves me scratching my head as to why good firms aren’t more direct about it. I presume there are reports to LPs when you’re fundraising that I’m just not seeing.

    1. fredwilson

      there are firms that use a budget for management fees instead of a percentage of the fund. there are also firms that charge a fee based on investments made as opposed to capital raised. we do that in our Opportunity Fund and as a result the fees have never been more than $500k a year even though its a $170mm fund.performance reporting is usually confidential, but since a number of USV’s LPs are public entities, our returns are disclosed publiclythis data is old but it was accurate at the time it was posted

      1. Ivan Kirigin

        Very interesting data, thanks for sharing! It really highlights how long answers take to come to fruition, because even current value of investments isn’t final.

  34. Ales Spetic

    Fred’s recommendations makes perfect sense from founder’s or VC’s perspective. However there is another stream of thought that is often advocated by startup CEO’s. As a CEOs we have obligation to minimise risks and get the needed resources to grow the business. And resources often spell cash. I’m not advocating rounds and sizes that I don’t understand, however a difference between 2 and 5 can mean that the management has only one shot and has to go back to negotiate for another if the first one didn’t work. With extra cash, he can do a lot more and has more muscle to do his job.If all goes well, small round is of course better, for the stated reasons. If it doesn’t, founders and management are cornered anyway, and need to renegotiate from a weaker position.

  35. John Maloney

    Good post, FredRe: Tumblr fundraising it went like this:775k4.55m20m85mFortunately for us USV was there for the entire run

    1. pointsnfigures

      Assume that’s money in the business-what was the corresponding valuation along the way?

    2. fredwilson

      i was pretty close!

  36. Jessica Bloomgarden

    Your argument on how this is in the best interest for the entrepreneur is flawed. “You can raise $3M later at a higher price” doesn’t change their ownership amount at the current round or necessarily have a direct impact on their ownership in the future.I do think there is an argument to be made for the entrepreneur taking less money and lower valuations, but you don’t make it. That argument is in retaining optionality to exit at a lower amount where they would be well off but would fall below the base return an investor would accept.

  37. FuturistLab

    Fred: Your point about playing ‘that game’ is spot on. I don’t know if the issue is deal flow or just larger amounts of capital being allocated from LPs with valley vs. east coast but it seems that west coast money will get you a higher initial valuation but east coast money wants to build a business and has a more traditional valuation metric. Do you see this, too? Further, how has effected outcomes in your opinion?

  38. Charlie Crystle

    Late to the party.The $5 million is a better deal–if the investors are worth interacting with for the next 3 to 10 years.But in most non-hardware tech companies these days, you can prove a lot with $2 million, and having the right partner with $2 million is a much safer, wiser bet than taking $5 million now. That extra comfort of additional money doesn’t really help and can hurt.You can feel too safe.What really matters beyond execution, beyond relationship, etc, are the exit metrics and terms, when it comes down to it. $5 million at $20 m pre is not a great deal if there are layers of performance targets, liquidation preferences, warrants etc.I’d probably take the $2 million.

    1. ShanaC

      even later that you -bascially you think this is about the relationship

      1. Charlie Crystle

        in any deal there are a lot of salient points. Valuation, terms, and relationship are pretty much at at the top. I suspect he’s referring to a very current deal.

  39. panterosa,

    This post is great! It’s like birth control for those wanting to get in bed with VC’s !!

  40. Jack Holt

    Very helpful stuff and specifically timely for us. Thanks.

  41. Brian Crain

    Taking the 20% @10mm and the additional 3mm later, will be cheaper if…- your VC just loves you, loves you, loves you soooo much he gives you all that money for 0% equity- he then even tops himself by giving you another 1mm for free because… he never really wanted the C in VC anyway πŸ™‚

  42. Pascal

    Fred,I am not sure I understand the implied Maths of “The answer is you can get the other $3mm later at an even higher price”.If a founding team is diluted by 20%, they are diluted and there is not much you can do about it in both cases.What I think is more important is not the difference in valuation, but two things:- optionality- fit with the firm 5 years ago, a Company I cofounded got 2 term sheets, for the same equity stake, one offering $6M from a very well known firm and another one offering $11M from a less prestigious but still good firm. We took the $11M.With hindsight, it was a mistake, but because our very high implied valuation prevented some earlier exit to happen, and also because the firm was less good.Had our Company been a home run vs. a first base hit, it would have been a wise choice financially, but for a first base hit, raising more means with liquid prefs that it is less advantageous for the founders…

  43. Ji Eun (Jamie) Lee

    Wow, this is great stuff. I’d love to see more entries like this one on AVC. Specific, values-driven, and provides both an insider’s look and an easy-to-follow breakdown of how the numbers work. Will be forwarding this one to many of my entrepreneur friends. Thanks for sharing knowledge, Fred! πŸ™‚

  44. Guest

    I was in a term sheet class in which the cap table of Skype at angel and seed round was discussed. At that point the founders were prepared to give away double the 20% at half of the $600k that David Karp did.A few years down the line and its $billions exit, everyone got N-fold the ROI that the angel and seed round valuation indicated.The main thing is simply the personal chemistry and values fit between founders and investors. That trumps cap tables and valuations and isn’t so readily balance sheeted.

  45. andyidsinga

    viewing this post through a diff lens for a min: i enjoy reading/watching you sell usv through the blog ..theres a lesson in sales aside from the content itself.i think you answer the questions : why buy anything? and why buy usv? ..but the ‘why buy now?’ seems missing :)#naivecritique #hashtag

  46. davidhclark

    One of my favorites. Thanks, Fred.

  47. BostonBizPerson

    “You might ask “how can taking $2mm for 20% be better than taking $5mm for 20%?” and you’d be right asking that question. The answer is you can get the other $3mm later at an even higher price.”Most founders find higher valuations irresistible! So this really is the key question but not the best answer. The best answer is that seeds of doom are planted at the moment you close a round at a high price. Boards grow disgruntled with management and fire the founder, disagreements form between older and newer investors, the VCs may pressure the CEO to do inside rounds to preserve valuations, the Board may feel compelled to gamble in order to make the high valuations come true or may delay necessary pivots, and you may not be able to find new investors for future rounds without a recap and this could lead to further bad behaviors. As others have noted here, you can also lose the chance to sell partway through the process, because you may be forced to wait until you grow into your valuation.Friends, if you should find yourself lucky enough to have many term sheets, save yourself these agonies. Raise money at the “true and fair valuation” of the company and not higher. Use the excess demand to let you pick the best quality people. Build toward success in future rounds – because it’s the last round that truly matters.

  48. ricew

    Fred,This paragraph doesn’t really make sense to me…”We are also very much focused on what is in the best interest of the entrepreneur. You might ask “how can taking $2mm for 20% be better than taking $5mm for 20%?” and you’d be right asking that question. The answer is you can get the other $3mm later at an even higher price. That has been the history of many of our investments.”$5mm for 20% ($20mm pre) is by definition better than $2mm for 20%. The argument your making of taking $3mm later is for a scenario that may not exist i.e. you’re holding dilution constant with both scenarios and there may not be an opportunity in the market for $2mm at that $20mm pre-money valuation. So raising the $3mm later at a higher price doesn’t really benefit them at all because they will have the same ownership in the company regardless if they take the $5mm or the $2mm. The only downside (assuming additional money doesn’t change the entrepreneur’s behavior) is having to live up to that valuation and the risk of a future down round for both anti-dilution and perceived momentum by the press, future investors, future acquirers, public markets, and future employees.

  49. sameer

    I had a short and simple illustration to share Holding 1% of the #startup that d sell ~$200 mil ?you ll make 250 k P.A. @ ~4 yrs lock-in via @noahkagan

  50. enthrense

    The world is divided between those who provide funding and those who consume funding. Funding can be either debt or equity or a combination but at the end of the day, it is all just money and it has a price tag on it.Die Abnehm LΓΆsung

  51. Pete Griffiths

    I think it’s fairly straightforward.a) you are better having 10% of something than 100% of nothingb) to create and hence ‘have’ something takes a teamc) VCs (if any) become part of the team – they will affect the team and hence the likelihood of success or failured) take whatever money makes the team stronger

  52. Nikhil Basu Trivedi

    this is a fantastic post – thank you fred

  53. John Revay

    I saw this link in this week’s Benedict Evans newsletter – Paul Grahams post on startup investing trends. After reading Paul’s post – I thought back to what you wrote here and thought there were many similarities – especially at the end of the post.