Why your VCs want you to raise a large round

From 5 Best-Kept Secrets About Venture Capital by Jason Lemkin:

Valuation increases really matter to most VCs, so they want you to go raise a big round.

VCs only make profits on an exit–an IPO or a sale of a portfolio company. But they make money on management fees too, and to get them, they need to raise multiple venture funds. They need to raise another fund. When they go to raise another fund, some and probably even most of their track record is still going to be illiquid, in companies that haven’t yet gone public or been acquired.

Those illiquid companies will be valued based on their most recent valuations. If you as a founder raise another round at 2x-3x the price of last one, VCs can tell their own investors, the LPs, how strong the return on this investment has been–even if it’s just paper gains. They can sell this when they raise their next venture fund. If there isn’t another fund, the venture firm just becomes a zombie.

Notes:
(1) Since the size of a round is always proportionate to its valuation, this means it’s in your VCs’ interests to have you raise a large round.
(2) A large round has many advantages — capital can be used as an offensive strategy. But a large round is not always best for the company, the founder or the team. As Rob Go says there, “modest sized rounds focus a team and establish discipline”.
(3) So add this to the list of potential conflicts of interest between companies and VCs.

2 thoughts on “Why your VCs want you to raise a large round

  1. Actually, I would argue that this issue differentiates good Venture capitalists from bad ones. The good ones do not care a whit about interim valuations. They only care about cash on cash multiples and hence should optimize for the best outcomes for their companies over the long term.

    The others, well they mark very risky investments to market and then can watch these inherently risky investments go poof…just like the banks in 2008.

    Be wary of all who “mark to market” – it tends to over emphasize frothy markets, discount risk and end in tears.

  2. This VC sounds like he/she has only made one investment and the entire track record of the fund and future of the GP relies on this investment. Certainly not the case for well-established funds (or any fund with multiple halfway decent investments for that matter).

    In general, it’s true that there are sometimes conflicts between the goals of the company and the goals of the VC. However, a good, honest VC would be forthright about this dynamic rather than aggressively pushing his/her own agenda on a startup company’s management team.

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