Now every Venture-powered startup is vying for reserves

A lot has changed in venture capital since the beginning of the year, and not many founders fully understand it. It’s just a radically different business than it was in January. And the founders really don’t need to understand that All Changes in venture capital. But they must understand some.

One is the concept “Reserves”, Which is very important for VCs, but not something founders usually need to understand in The Best of Times.. Because in the best of times, there is always more money to invest in the top performersEven mediocre performers. The money almost always comes from somewhere to write the second and third checks to the winners.

But in bad times, in the most stressful times of adventure (like now)… that money for the second and third checks almost disappears.

What is happening? Let’s walk through it.

Imagine a “typical” equity fund of $150 million. (Not really a typical chest, but in the end, most chests of this size are run roughly the same way):

  • 20% or more of the fund is depreciated from the fee. That leaves only $120 million for investment. (Yes, there are ways to “recycle” to get the amount available for investment, but that’s not critical for this analysis.)
  • The fund typically makes 20-30 underlying investments using half of that $120 million, so maybe $2.5 million on average ($2.5 million x 25 = $62.5 million)
  • The other half of the fund, after fees, is “reserved” for follow-up investments. Pro ratas, second and third check in later rounds and some bridge rounds.

Now, not every one of these 25 investments will make another round, but often 70%+ will make another round. That means more than 20 investments, all of which will need another check. Of the total $65 million.

Now when times are good, and ups and downs happen seemingly every week, there isn’t much tension. If you, as a VC, invest $10 million up front in the beginning, and say it’s 2021 and the same startup is round 100 times at a $300 million valuation, then this early-stage venture capital fund can pick and choose whether to invest more or not. No one will care too much if they invest in this later stage, given that it is oversubscribed. And the price is 30x higher, so anything but a huge check wouldn’t really move the needle in the property. Several funds have also raised separate opportunity funds to invest more money in these subsequent trades.

Let’s fast-forward to 2022. Now, these 5x-10x spikes are hard to do. Maybe even more difficult. Now, imagine that 10 of these 20 portfolio companies are doing well but don’t have Tiger Global or Softbank to magically make the next round at a high price. This fund is worth $150 million now she has To invest in those ten rounds to support them. Sometimes it almost has to.

Now, there are 10 portfolio companies vying for a slice of $62.5 million in reserves. Imagine that the first half has already been invested, so there are only $31 million left.

Suddenly, you’re in sorting mode:

  • Venture capital partners start to worry that their investments won’t get any of the scarce reserves now
  • The volume of extension validation, incorporation rounds 2 and more is being cut short, because many existing businesses need checks
  • In good times, reserves It seems Less rare, so on the margin, portfolio companies with good but not so good performance get another check. The exact opposite happens in difficult times.
  • If you can not write this next check as a VC, then you can try. Not much left.
  • Therefore, fewer and fewer hands are raised to help write additional checks in portfolio companies that need it.

This becomes more severe with both new chests and old chests. Old funds run out of reserves. For example, since 2017, SaaStr Fund I has invested $61 million out of $68 million. There is only $7 million left to invest in the next four or five years. This is tight (I’ll admit). Even tougher than I had designed.

Newer funds are under pressure to be more diligent. The bar for second checks is higher there, too, with the Reserves suddenly looking more defensive than they did a year ago. Indeed, with founders competing with everyone else in their venture capital portfolios for now-scarce dollar reserves.

net, your venture capital has a lot more to invest in you than it did just a few months ago, and internal auditing on these checks is on the way up. This alone causes a lot of stress, and makes the extension rounds more difficult. Funds pull up spreadsheets, force companies to rank their portfolios, and start allocating what little remains to the real winners.

In fact, many veteran CEOs and venture capitalists have very quickly rolled out extensions this year to take advantage of these limited pools of reserve capital.

In many cases, it is too late now.

A reason to be more conservative in how you spend your expensive investment capital.

And also – ask. Ask your investment capital how much is left to invest, and what it takes. If they are in a cage, push them harder. You deserve to know. In fact, as founders, it is your duty to know. just ask. Nobody asks.

Related post here:

Do you need a second check of your investment capital? Here’s how “Reserves” work

Posted on August 1, 2022