Tech Pique (20 September)
Active VC Management
One of the most asked questions after my last post was in relation to the following sentence:
“Paradoxically, later stage investors are generally more active than early stage investors and in particular angel investors.”
Why is this case?
It has to do with the VC model and in particular, risk, fund size and fees.
A brief note about Angel Investors - generally, angel investing is not an investor’s “day job” and so already they are pressed for time to be active with their portfolio companies. Moreover, diversification at angel stage is crucial to maximise return and mitigate risk. Without going into detail here, a portfolio of at least 20 companies is recommended. As such, an angel investor has limited capacity to be actively involved in all 20 investments.
Moving on to VCs.
As noted the ability to be active and support portfolio companies is largely driven by risk, fund size and fees.
Risk
All VCs seek to maximise returns while mitigating risk. Early stage investors are taking on more single investment risk and thus need to invest in a larger portfolio of companies vs. later stage investors. While models vary, early stage investors generally invest in 20+ portfolio companies per fund to mitigate the risks of investing at the early stage. Later stage investors aren’t taking on as much company specific risk and so can afford to invest in fewer companies overall. Again, while models vary, later stage investors generally invest in around 10 companies per fund.
Fund size
All investors seek to raise a fund that they can generally deploy in 2-3 years for their initial investments, while also leaving capital available to follow-on. Early stage investors generally invest smaller amounts earlier, again because of the risk of investing early, vs. later stage investors who need to invest larger amounts in later stage companies to support growth (with less risk vs. early stage investors). In Australia, early stage fund sizes range from $10m - $30m whereas later stage funds can be as large as $1bn (although the general range is $50m - $200m).
Fees
VCs generally charge 2% (usually of committed capital) in annual management fees. That is, for a $20m Fund, a VC is generating $400k in yearly income, assuming one fund only and no other sources of revenue. A $100m fund, generates $2m in management fee revenue per annum.
As a result of the above, a later stage fund, which generates more revenue and can thus hire more team members to be actively support portfolio companies, while making less investments has the capacity to support its portfolio companies more actively than an early stage fund, which generates less revenue but makes more investments.