20 VC 030 VC Funds, Angels and IPOs with John Taylor, Head of Research @ NVCA



In episode 30 of the 20 Minutes VC, host Harry Stebings interviews John Taylor, head of research at the National Venture Capital Association. Taylor discusses the origins and sources of venture capital funding, highlighting the shift from pension funds to family offices, sovereign wealth funds, and educational institutions. He outlines investor expectations for venture fund returns, typically seeking 3-5% above public market returns, and the standard management fee structure for VC funds, which includes a 2% management fee and a 20% carry on profits. Taylor also covers the role of VCs in providing talent and connections to startups, the trend of VCs making angel investments, and the increasing concentration of capital among fewer VC firms. Additionally, he touches on the changing dynamics of VC investments, with later-stage rounds involving non-traditional investors, and the factors that influence an entrepreneur's choice of VC partners.

Summary Notes

Introduction to the 20 Minutes VC Podcast

  • Episode 30 marks a milestone for the 20 Minutes VC podcast.
  • Host Harry Stebings introduces John Taylor, head of research at the National Venture Capital Association (NVCA).
  • John Taylor is recognized for his expertise in venture capital and entrepreneurial finance.
  • He co-founded the NVCA CFO task force which focuses on industry regulation, reporting, and transparency.
  • John Taylor is frequently quoted in major media outlets on venture capital topics.

Now, today's show is a special show as it's a bit of a milestone here at the 20 minutes VC being the 30th episode to celebrate this milestone.

This quote marks the significance of the podcast episode and introduces the guest, John Taylor, highlighting his credentials and relevance to the venture capital industry.

Venture Capital Funding Sources

  • Venture capitalists (VCs) raise funds from third-party sources, differentiating them from angel investors who use their own money.
  • Institutional investors have historically been the primary source of VC funds.
  • Pension funds played a crucial role in the early days of venture capital due to changes in the "prudent man rule."
  • Currently, family offices, sovereign wealth funds, universities, and charitable foundations are significant contributors to VC funds.
  • Pension funds are less involved due to the shift from defined benefit plans and the inability to commit to long-term lockup periods.

In the case of VC, the money is third party money. They're raising it from someone, somewhere, typically an institutional investor.

This quote explains the distinction between venture capitalists and angel investors, emphasizing that VCs raise money from external entities, not their own funds.

Institutional Investor Expectations and Management Fees

  • Institutional investors expect a premium return from VC funds due to higher risk and illiquidity.
  • The common benchmark for expected returns is 300 to 500 basis points above public market returns, equating to a 9-11% return if public markets yield 6%.
  • Historically, VC funds have netted investors about 25% to 30% returns.
  • The success of VC funds has led to increased investment from institutional investors.
  • However, large institutions may struggle to invest in smaller VC funds due to the difficulty in allocating small amounts of capital.

So if they're thinking they can do 6% return in the public markets, and then they're looking on a hole from venture for at least nine to 11% returns.

This quote details the expected return rates that institutional investors seek from venture capital investments compared to public market investments, indicating the premium they expect due to the associated risks and illiquidity of VC investments.

Venture Capital Fund Structure and Economics

  • Venture capital (VC) funds negotiate terms and conditions, including management fees and profit-sharing structures.
  • Management fees are typically around 2% and cover operational costs such as staff salaries and deal sourcing.
  • VCs earn a significant portion of their income through carried interest (carry), commonly set at 20%, which is a share of the capital gains earned by the fund.
  • The primary goal is for the fund's investments to appreciate in value, benefiting investors, VCs, and the companies they invest in.
  • The shared success model in VC is unique compared to other areas of the economic world.

"Many funds charge roughly 2% for management fees, and that's the cost of the staff and keeping the doors open and sourcing deals and providing the talent to manage the money."

This quote explains the purpose of management fees in venture capital funds, which is to cover the operational costs of running the fund.

"The 2%, and typically the VC makes its money, his or her money, on sharing a portion of the capital gains with the investors. And typically what they call 20% carry is what you see a lot."

The quote outlines how VCs make money, emphasizing the standard carried interest rate of 20% on profits made by the fund.

VC Angel Investing Practices

  • Some VCs make angel investments independently from the funds they manage.
  • Founders of VC firms who retire often continue to invest personally due to their passion for building companies.
  • Younger VCs typically invest through the fund rather than individually.

"You have a lot of the original founders of the venture industry now retiring... they'll go out and they'll make their own investments."

This quote indicates that retired VC industry founders commonly make personal angel investments after leaving their funds.

VC Fund Investment Lockup Periods

  • VC funds have long lockup periods, often 10-13 years, compared to mutual funds.
  • Initial investment periods can last 3-5 years, with additional time needed for companies to develop and scale.
  • Recent trends show companies waiting longer to go public, with IPOs taking place many years after initial investments.
  • Biotech companies have been a significant portion of IPOs in recent years due to pent-up demand and public interest cycles.

"The bottom line is that the money typically first goes in... that could be twelve years or longer from the initial investment."

The quote explains the reason for long lockup periods in VC funds, highlighting the time it takes for companies to mature and reach IPO.

"The interesting thing is that the majority of the ipos in each of that period were biotech companies, which historically is only about 20% of the money."

This quote discusses the recent prevalence of biotech IPOs, suggesting a shift in the types of companies going public within the venture capital landscape.

  • VCs focus on the potential upside when investing.
  • The VC industry has become more complex and specialized, with a shift towards subsector-specific investments.
  • Geographic proximity between VCs and companies is less critical than sector alignment.

"Really? Well, yeah, I think it's all on the upside."

This quote emphasizes that VCs are primarily interested in the potential for significant returns when making investments.

"It's much, much more sector specific. Not a sector specific, but subsector specific."

The quote reflects the increasing specialization within the VC industry, where investments are made based on detailed knowledge of subsectors rather than broad industry categories.

Geographic Independence and Investment Strategies

  • Venture capital firms are less reliant on geography and more focused on company potential, regardless of location.
  • West Coast firms are investing in technologies from universities or government labs outside their usual geographic scope.
  • Direct investments or seeking local partners are methods used by firms to engage with opportunities.
  • Investment decisions are influenced by the potential synergy with the firm's network and existing portfolio.

"So you even see some of the west coastal coastal firms making investments elsewhere, maybe a university or government lab or something has an intriguing encryption or some kind of ecommerce technology."

This quote explains the trend of venture capital firms looking beyond their traditional geographic boundaries to invest in promising technologies from various sources.

Venture Capitalist Time Management and Board Involvement

  • Venture capitalists consider time as their most valuable and limited resource.
  • A typical venture capitalist can manage around six board seats effectively.
  • This limitation influences their investment decisions, as they aim to choose winners within their capacity.

"And the number comes back six. And it was true during and after the bubble, it's been true since, that a venture capitalist with six board seats has a very full workload."

This quote highlights the findings of a study on the typical board-level workload of a venture capitalist, emphasizing the practical limit of board positions one can hold.

Lean VC Model vs. Traditional VC Engagement

  • There are different venture capital models, with some not requiring board seats.
  • The traditional model usually involves a VC taking a board seat as part of the financing round.
  • Venture firms may offer varying levels of service and engagement, with some providing extensive resources to support startups.

"Now, a lot of the rounds are syndicated, and at some point the value added to the VC is the VC's expertise and Rolodex and experience, connections, everything else."

This quote discusses the value that venture capitalists bring to the table, which extends beyond just financial investment to include expertise, connections, and experience.

The Most Important Value a VC Can Add to a Startup

  • The most critical value a VC can provide is helping startups with talent acquisition.
  • VCs have networks and experience that can assist in scaling a company's team.
  • Startups often lack the knowledge to find the necessary talent for growth, which VCs can facilitate.

"Gosh, it's tough. I think the short answer is people, you have many one and two person companies that's gotten funding, but I can't think maybe with the exception of Enron, a one or two person company that's gone public."

This quote emphasizes the importance of human resources in a startup's journey to success and the role of VCs in facilitating the growth of the company's team.

  • The trend of VCs coming directly from business schools is not significant.
  • Top business schools often require relevant work experience, which affects the entry into the VC industry.
  • Experience and networks play a crucial role in becoming a venture capitalist.

"Tough question to answer, because many of the top business schools are now requiring that their people have four or five years of relevant or domain work experience."

This quote addresses the trend of business school graduates entering the VC industry and the prerequisites of work experience that influence this pathway.

Concentration of Capital in VC Industry

  • Capital is increasingly being concentrated among larger firms and experienced individuals.
  • There is a current lack of robust opportunities in the venture capital job market.

"A lot of the capital is being concentrated by larger firms and in many cases experienced hands."

This quote highlights the trend of capital concentration in the venture capital industry, indicating that larger and more experienced firms are amassing more capital, potentially making it challenging for smaller or newer firms to compete.

Competition Among VCs in High-Demand Rounds

  • VCs compete based on the talent they can bring to a growing company.
  • Deal terms, valuations, and the amount of money involved are crucial in competition.
  • The size of funding rounds has increased significantly, with venture-led rounds seeing a dramatic rise in total dollars invested.

"Well, I think it goes back to the question of talent, who they can bring in as the company grows."

This quote emphasizes the importance of the value-added services, such as the ability to attract talent, that venture capitalists offer to startups as a way to differentiate themselves in competitive funding rounds.

Dynamic Changes in VC Funding Rounds

  • There's a shift in the dynamic of funding rounds, especially in Silicon Valley.
  • Total investment size in rounds is expanding, sometimes by 40-50%.
  • Corporate venture capital groups, mutual funds, hedge funds, and private equity players are increasingly active in later-stage funding rounds.
  • Entrepreneurs are considering VCs' connections and experience with these third-party investors when choosing a partner for later rounds.

"The VCs themselves are coming to the table with roughly the same amount of money they have the past few years. But we're seeing the total amount invested. The total size of these rounds expanding by 40 50%."

This quote describes the substantial growth in the size of funding rounds, indicating that while individual VC contributions remain similar, the overall pool of capital has grown due to the involvement of a wider array of investors.

Prorata Conditions and Prior Investors' Participation

  • Participation of prior investors in later rounds is negotiated on a case-by-case basis.
  • Early-stage funds may face difficulties in contributing to later rounds due to the increased capital required, leading to dilution.
  • Early investors may accept dilution if the overall outcome is expected to be positive.

"All of this is negotiated round by round, and lots of times there is some kind of participation."

This quote points out that the terms of participation for prior investors in subsequent funding rounds are not standardized and must be negotiated each time, which can vary greatly depending on the circumstances.

The Entrepreneur's Journey and Capital Requirements

  • Entrepreneurs must consider the entire journey, including total capital needed for growth.
  • Companies like Uber have raised exceptionally large rounds of financing, challenging traditional venture funding models.
  • Entrepreneurs must decide on the timing of transitioning from private to public and whether staying private longer is beneficial.

"Am I going to need $10 million to get to where I'm going? Am I going to need 100 million?"

This quote underscores the critical financial planning entrepreneurs must undertake, assessing the total amount of capital required to achieve their long-term business objectives.

Acknowledgment and Resources

  • Harry Stebings thanks John Taylor for his insights and contribution to the show.
  • Listeners are directed to the blog and the NVCA website for additional resources and information.

"Harry, it's a pleasure. Good talking with you."

This quote concludes the conversation on a positive note, with mutual appreciation for the discussion and the insights shared.

"Now, for all the resources and figures mentioned in today's show, do head on over to our blog at www.thetomentyminutevc.com."

This quote provides listeners with directions to access further resources and information, highlighting the show's commitment to offering additional value beyond the podcast conversation.

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