Why VC funds will increase tenfold (10x)

MK Venture Capital
9 min readOct 15, 2020

Six months ago, many venture capital firms warned the founders of their start-ups to ensure sufficient liquidity in the company in time to be prepared for a crisis.

Today, we can see that several very well-known start-ups have had to or still have to rethink and restructure their business model in order to survive. At the same time, we are currently experiencing a flood of IPOs of VC-financed start-ups. The returns achieved by VCs with IPOs can only cause amazement.

Is a paradigm shift happening?

I maintain that we are not experiencing a paradigm shift. Company valuations will continue to be based on KPIs such as revenues, EBITDA, competitive situation, etc. What is probably new for this era, however, is the speed with which market-dominant new companies are emerging.

Technological progress is leading to increasing automation of the economy, so that human labor is largely devalued and not needed anymore. Many people are becoming superfluous as labor and can no longer contribute to the productivity of the economy.

Due to the dramatic expansion of the money supply, the marginal productivity of capital is decreasing more and more and is now, as interest rates show, more or less already at zero.

A fair reward

With the help of three VC-financed start-ups, I would like to make a plea for the venture capital culture. Market economy elements are increasingly being forgotten in our society today. Venture capital supports innovative capitalism in the Schumpeterian sense of creative destruction. Money that is allocated to venture capital exposes itself to the greatest possible risk. The reward for the risk should therefore be appropriately high. The following examples show why the achievable returns in venture capital, especially in funds, will continue to rise.

#1 Snowflake and its investors

Logo of Snowflake

Snowflake offers a software solution that helps companies to optimally manage and utilize large data inventories in the cloud. At Snowflake’s IPO, interested investors were able to subscribe at USD 120 per share. 28 million shares were sold. Snowflake raised USD 3.36 billion for this.

The start-up was founded in 2011.

Sutter Hill Ventures

Sutter Hill Ventures (SVH) has invested USD 5 million in a Series A round in August 2012 at a price of USD 0.35 and received 14,240,500 shares (profit factor 750x). In total, SHV has purchased 41,919,208 shares over the period at an average price of $3.33 USD. Since the IPO, these shares are worth almost 11 billion USD, a profit factor of 80x at fund level. This corresponds to a return of about 70% per year.

SVH also participated in the later financing rounds. The special thing about SHV is that the VC manages a so-called Evergreen Fund. This fund structure has an infinite duration. This means that start-ups can develop more optimally and are not subject to additional pressure that could be triggered by fund maturities.

Redpoint Ventures

VC Redpoint has invested through various funds: Redpoint Ventures V, Redpoint Ventures V and Redpoint Omega III. According to the IPO prospectus, for example, the 400 million USD fund Redpoint Venture V (Vintage 2013) with 19,801,389 shares achieved a value of 4.9 billion USD only on this position, i.e. a factor of 12x at fund level. Considering that a USD 400 million fund is a very large fund by venture capital standards and can therefore invest rather late in the game (starting with Series B), results with a profit factor of 10x and more within 10 years are an outstanding performance.

Altimeter Private Partners

Altimeter Private Partners Fund I, a USD 66 million fund (Vintage 2013), held 15,037,910 Snowflake shares. The fund purchased at USD 2.30. This results in a profit of almost USD 3.7 billion for a USD 66 million fund, a profit factor of 55x at fund level.

Sequoia

Tier 1 venture capitalist Sequoia has invested through several funds starting with the Series E round. The Sequoia Capital U.S. Growth Fund VII (Vintage 2018) with a volume of approximately USD 1 billion has acquired 6,291,460 shares. Despite the short holding period, the profit has already exceeded USD 1.5 billion. The fund could pay back 1.5 times the subscription volume to investors after only 2 years. How much capital Sequoia has drawn down cannot be determined from the documents. Experience shows that the retrieval rate is between 50 and 70%.

The price development is as follows: (Quelle https://sec.report/Document/0001628280-20-013667/)

#2 Unity and its investors

Unity offers a graphics engine for computer games, which is used in games such as Doom, Call of Duty mobile, NASCAR or PGA Tour. Unity has also been announced for League of Legends Wild Rift.

Draper Fisher Jurvetson

The late stage investor DJF has invested through various funds and has acquired a total of 1.8% of the shares. For example, DFJ Growth 2013 Parallel Fund LLC invested in 253,119 shares of Unity as part of the Series C financing 2016. The profit from this position amounts to USD 17 million. The fund started with USD 20 million.

When Unity went public, interested investors were able to subscribe at 52 USD per share. 25 million shares were sold. For this Unity has raised 1.3 billion USD.

Silver Lake

The private equity investor Silver Lake has acquired a total of 18.2% of the shares. Interestingly, BuyOut Fund Silver Lake Partners IV, L.P. has acquired a total of 28,356,238 shares, a majority of which were purchased under the Series D financing. The PE investor has invested a total of $322 million in the Startup Unity. The fund, launched in 2013, has a total volume of $10.5 billion. The average purchase price per share was USD 7.44. At the current market price of USD 85, the profit for all Silver Lake funds is approximately USD 3.3 billion. What is surprising is the fact that private equity is now covertly making larger individual bets in the venture capital area.

Sequoia

The largest single shareholder is Sequoia. The shares were acquired through various funds. Sequoia Capital XII, L.P., which was launched in 2006 with a volume of USD 445 million, has acquired a total of 21,410,700 shares. It can be assumed that this fund only participated in Series A and Series B. Each VC fund has an investment period of 3 to a maximum of 5 years. The Series B of Unity took place in 2011, i.e. 5 years after the launch of the fund.

According to the issue prospectus, the share price for Series A was USD 0.33 and the price for Series B was USD 1.26. Series A brought in USD 7.8 million in new money for Unity at that time. Considering that at the time of a Series A, the founders still own more than 50% of the shares, Unity must have been valued at at least USD 15 million at that time, which is quite high. Sequoia was the lead investor in the Series A, the co-investors were three business angels (Paul Heydon, Diane Greene, David Gardner). Due to the scale of the deal, it can be assumed that Sequoia took over approximately 75% of Series A. The remaining shares were subscribed for in this fund during Series B. Series B was led by WestSummit Capital (WestSummit Global Technology Fund, LP 2011). We estimate that WestSummit’s fund should have a profit factor of approximately 4.5x just because of the Unity Investment. Another co-investor was iGlobe Partners. The profit in Sequoia Capital XII, L.P. is just under USD 1.78 billion, so that the fund achieved a 4x only because of this position.

#3 Palantir and its investors

For many years now, Palantir has been shrouded in mystery. With the IPO a part of these secrets will now be revealed.

Palantir offers software for the analysis of large amounts of data, which are used especially in the military and intelligence sector. But Palantir also covers civil applications. For example, Scuderia Ferrari is a customer.

Direct Listing

When Palantir went public, new shares were not offered as in normal IPOs, but already issued shares may be traded directly on the stock exchange. Palantir has therefore not received any new money. The opening price was over 10 USD per share.

Classes of shares

Palantir has 3 classes of shares: A shares, B shares and F shares. Only the A shares can be traded on the stock exchange. B shares have all existing investors who can exchange them for A shares if they wish. F shares are held by the founders.

A direct listing is made for two reasons.

If the startup does not need new money

to give existing shareholders the opportunity to trade shares freely

save money, since a normal IPO costs at least 3% of the issue proceeds

Initial investors in Palantir

The first VC invested USD 7.5 million in a Series A in July 2006. This was Oakhouse Partners.

In November 2006, a Series B was already carried out. The USD 10.5 million came from the British RELX Group.

In 2010 there was a Series D round for 90 million USD.

The prices of some investors turned out that way:

  • Oakhouse Partners: 0.10 USD per share -> profit factor approx. 100x
  • RELX Group: 0.06 USD per share -> profit factor approx. 166x
  • Ulu Ventures:: 0.80 US per share
  • Glynn Capital: USD 0.80 per share

Peter Thiel

One of the big winners is Peter Thiel and his Founders Fund. Peter Thiel holds 29.8% of Palantir, his VC Arm Founders Fund a total of 12.7% distributed among various funds.

Summary

Cambridge Associates publishes for VC Fonds Vintage 2010 a threshold TVPI, i.e. the value at which the best quartile starts, of 3.41x for the upper quartile. The median of the results is 2.12x.

For Vintage 2011 the threshold value TVPI for the 1st quartile is given as 2.71x.

A modeling over 15 funds shows that the net result can be around 8.1x, although only a quarter of the selected funds can be classified in the 1st quartile. The remaining 75% should be in the 2nd quartile. The art lies therefore in this:

#1 not to select any fund from the 3rd and 4th quartil

#2 to gain access to the top funds with this small investment amount (here 1 million EUR).

All information and further details can be found in the S-1 IPO prospectus. To read them visit our website.

Memo: If you want to replicate the portfolio with direct investments, you need about 66 TEUR per startup. It would require 225 notarial certifications. Follow-up financing is excluded. The pre-money valuation should never exceed EUR 2 million in order to maintain a significant stake. If dilution is only 80%, this investment strategy with two Unicorns will earn back approximately the capital invested. But nothing more.

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Mato Krahl

MK Venture Capital

mk-vc.com

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