We've recently covered about how paying "top comp" for "top talent" isn't entirely accurate
Today we're going to talk about what happens when companies with first time founders raise big Series B rounds.
Spoiler alert: it's never pretty.
A few years back I was at a dinner, speaking to a VP of Sales (who has since become a founder).
He explained to me that a big Series B is almost always followed by mass firings among the sales team. This was 2018 or so, and the number he used was $50m or so.
If we take inflation into account, that number is $70m or so these days.
I'm yet to see an instance where this isn't the case.
The founder in question took his own advice. He raised a $30m Series B, and followed it up with a $45m Series C.
Why is this?
A lot of it comes down to VC incentives.
Helpfully a friend who worked at a fund with $30b+ under management explained the economics of it all.
Venture capital is famous for having a slow feedback cycle.
Broadly speaking, it's about 10 years, from raising the fund, investing the money and then investors seeing a return.
This has stretched in recent years. Limited Partners who invested in Sequoia, who then invested in Stripe way back in 2009 / 2011 still haven't seen an IPO.
A few weeks ago there was news that Sequoia was offering liquidity to their LPs, at a $70b valuation.
So you're a Venture Capitalist. You raise funding from Limited Partners (universities, billionaires, foundations, institutions etc)
You raise a fund in 2024. Let's say the first fund is $100m
In 2027 you go back, and you raise a second fund. This might be a bit bigger (say $300m). This time you're able to show impressive gains in the companies you invested in for the first fund. These profits are of course only on paper.
Then in 2030 you go back and raise a third fund. This one is bigger again (say $500m). Again, this is based on the gains of the first two funds.
So while Venture Capitalists aren't necessarily trying to get their money back this year, they need to be able to mark their portfolios up, so they can raise their next fund.
Most VCs operate under a 2 & 20 fee model.
They charge 2% of Assets Under Management. They also keep 20% of the profits at the end of the day (this is usually after the principle is returned in full to investors + some sort of hurdle rate is applied).
But forget about the profits for a moment.
Let's focus on the management fee.
If you get 2% of the fund, and you run each of these funds for 10 years a piece, you've collected $180m in fees over a 16 year period.
Not bad!
But also, that's one hell of an incentive to show some impressive paper gains.
Regardless of how much a company has raised, it doesn't seem to change the timeline one bit.
I've heard "we have enough money for 5/6/8/10 years" etc etc
It doesn't matter.
That money gets spent.
If you think about a round of funding as being given money to grow revenue from $X to $Y, the main difference in a bigger Series B is that $Y just got much bigger.
You might have raised $15m to take your revenue from $5m in ARR to $20m, in a 24 month time frame.
But if you raise $90m, you need to go from $5m in ARR to $50m. Guess what. You're also operating on a 24 month time frame.
So you're running under a lot more pressure.
Here's what happens:
1: You bring on a sales leader
2: They get a massive quota
3: 3-6 months later they miss their sales targets
4: You fire the sales leader
5: You repeat this 2-3 times
A lot of money gets burned through. Employee morale tanks. You hire and fire a lot of people. Some revenue gets added, but it's a painful way to do it.
For the individual, these are companies you don't want to join. Especially if you're in the sales org.
The one exception: if the founders have either
1) founded a company that went public
2) had an exit of $500m+
But in that case, you're dealing with a different beast.
Half the management team are likely working together again.
They're singing from the same songbook.