The acronym stands for Net Asset Values. Be forewarned: this is the more boring installment in the VC Money Pump series of columns (see part 1 and part 2 ). Worse than spreadsheets and compound interest calculations, today’s topic forces us to deal with FASB (Federal Accounting Standard Board) regulations. Expensive futility as far as we are concerned.
For perspective, let’s go back to the previous crisis: the Internet Bubble. Fortunes were lost when Cisco’s stock went down by 90% — with the entire high-tech sector. But new fortunes were about to be made.
First, there were the political fortunes of posturing solons. Seeing the damage done by accounting fraud at Enron and WorldCom, canny politicians seized the opportunity to harness the public’s ire to their career’s progress. Paul Sarbanes and Michael Oxley begat what we now call Sarbox (the Sarbanes-Oxley Act of 2002), a new set of much stricter accounting rules. To the angry investing public, to the recently fired as a result of the downturn the senators’ message was clear: We’re here for you, we’ll throw the Armani-suited thieves in jail and we’re putting in place the safeguards needed to avoid a repeat of such catastrophe. More
Last week, with Excel’s help, we looked at the “simple” computation of a VC fund’s rate of return. This week: Reserves, a most important sets of numbers.
As a rule, for every dollar initially invested in a company, we immediately set aside an additional $2 or even $3 as a reserve for future rounds, future injections of capital. Entrepreneurs often tell us they’ll only need one round, this round of financing before reaching the cash-flow positive nirvana. I know, when an entrepreneur, I did it (to) myself, several times… We don’t argue, we smile, nod and enter the appropriate reserve amount in a spreadsheet.
Next, we try to forecast the additional rounds: one round in 15 months, perhaps, and another one 18 months later.
As we do this for every company in our portfolio, the spreadsheet tells us how much capital we’ve invested so far and, as companies develop and need more capital, how much will be required and when.
Then, the hard work starts. More
This week, I intend to take you through the pipes of a VC fund’s “money pump”. It starts with dollars coming in from our investors, our Limited Partners, LP, to be invested in entrepreneurs’ big ideas. Later, sometimes much later, money comes back to be shared between the LP and us, the General Partners, the GP. And, of course, there are those cases where we loose every penny. We’ll look at how the hits and misses balance and how we (try to) keep track of the streams.
One simple and, I’ll state it outright, simplistic, misleading assumption is the set of win/lose numbers. The theory varies, you’ll see why later. For today, I’ll just say we assume a $200M fund making 20 investments averaging $10M each. Out of these 20 investments, 6 are losers; 8 fall in the “money back” category, roughly returning what we put in, maybe a little more if we had an early exit; 6 are “winners”, returning between 4.5 and 6.5 times our money.
How much money does such a fund makes? What is the rate of return, the equivalent interest rate on the money put at risk by our LP? More