Putting the ownership debate to bed. For VCs, it (almost always) matters
In the world of Twitter VC, there’s little room for nuance. This applies to the “should ownership matter to a VC” debate as much as any other.
I find the debate pretty confusing, and I’m sure a lot of founders find it particularly unhelpful. How can ownership not matter?
To simplify things, generally the return on an investment equals the entry ownership (corrected for dilution) times exit valuation, so of course ownership matters! If a VC is trying to optimise returns, entry ownership matters!
Yes… but still, not everyone cares about it.
To help founders navigate this, I’ve tried to draw out the three investor profiles for whom ownership on entry genuinely doesn’t matter, and crucially, VCs almost never fit the profile. These are: the “ulterior motive” investor; the “opportunistic” investor; and the “any price will do” investor.
The “ulterior motive” investor: an investor where return on equity is not a driver of the decision to invest
These investors are usually trying to achieve something else from taking equity, such as the new angel who is “investing to learn”, or the Corporate Venture Capitalist, for whom being on the cap table is merely a “pay to play”, locking in the terms of a commercial partnership.
For this profile, any return on equity is of negligible importance, and so they are entirely indifferent to the ownership they achieve on entry. Tip to founders here: it’s really, really important to find out what these ulterior motives are up front, to avoid any differences in expectations down the line.
The “opportunistic” investor: an investor with no model portfolio construction, so any stake will do
This profile can start the year without any formal plan — by the end of it, they might have a portfolio with multiple 0.01% stakes; they might have a portfolio with a single 10% stake and nothing else. For this set, they have no targeted shape of the portfolio at all.
As far as I’m aware, this only applies to (some) angels — I believe that all professional VCs pitch their LPs with some sense of the portfolio construction they are targeting.
But why does having a target portfolio construction necessitate a concern about ownership?
At a high level, a portfolio construction is a model estimating how a fund hopes to hit their target return for their investors. It involves setting out the number of companies the fund wants to back; an outcome distribution across the portfolio (most importantly, the size of the winners); and some view of how much will be reserved for following on, if anything. Crucially, models always include some sense of how the fund will buy in to a startup’s equity for the first time. There may be multiple entry points (in different funding rounds), or even different approaches at the same round (e.g. lead cheques vs “taster” cheques), but all models involve either targeting:
- A certain % at entry (or a range of %)
- A certain $ size (or a range of $)
Clearly, for 1, target ownership matters, but ownership also (usually) matters for 2, it’s just buried!
Targeting a cash amount might sound like there are no restrictions on ownership, but unfortunately that’s not the case, because the variable connecting $ with %, is the valuation, and for almost everyone, valuation does matter.
Take the two valuation extremes — would a VC targeting a $400k ticket still want to participate if that $400k bought them 0.4% (post money of £100m) at seed? Or if that $400k bought them a huge amount — e.g. 40% (post money of $1m)?
Almost certainly not — so there are still guardrails on ownership in there somewhere — they’re just not obvious. If valuation matters, then the cash amount can be translated into a range of ownership levels that are “within range” for the investor.
The exception, then, is a fund with a portfolio construction targeting $ size, but one which is genuinely insensitive to the valuation of the company raising money…
The “any price will do” investor: an investor who is entirely insensitive to valuation, so has no guardrails on what stake their $ should buy
VCs in this group may have a portfolio construction, and a target $ on entry, but valuation is genuinely irrelevant, so they really don’t mind if their $400k converts to 40%, or 0.4%.
The rationale for this type of investor tends to be “I’m looking for exit valuations that are so high, that any form of ownership on entry will do, no matter how small, because even a tiny bit of a huge company is good enough for me”, and it particularly works for small funds.
The problem with identifying this set is that even those who say “valuation on entry doesn’t matter” are normally using a hyperbole. They REALLY mean “within reason, valuation doesn’t matter”. Somewhere very high is a valuation they just can’t stomach. It’s that valuation that can be used to calculate the fund’s “floor” on ownership. So ownership very often matters even where a fund claims to be insensitive to valuation. Differentiating between the genuinely valuation insensitive, and the fund using a clever marketing slogan, is crucial.
….………………..
So, Founders, if a prospective VC says “we don’t care about ownership”, try to sound what what profile the investor has. Do they genuinely not care, and if so, why not? In my view, if they’re a professional VC fund, looking to maximise returns on capital, with a portfolio construction, and they care about valuation (even a bit), then behind the marketing, ownership matters.
