The stake on the term sheet is not the stake on the exit waterfall. Project the dilution first, then ask whether the company can return the fund.
The exit value that returns a venture fund is the fund size divided by the stake you will still own at exit, not the stake you buy. A 100 million fund taking 10 per cent at seed, diluted by four later rounds to 4.78 per cent, needs a single exit of 2.09 billion to return the fund, more than twice the 1.0 billion the entry stake suggests.
Worked in full in The Venture Capital Associate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
"Could this company return the fund?" is the first question a venture partner asks of any seed or Series A deal, and associates are expected to answer it with a number. The number is simple to compute and routinely understated, because the stake on the term sheet is not the stake on the exit waterfall.
| Input | Value |
|---|---|
| Fund size, committed | 100 |
| Ownership bought at seed | 10% |
| Series A: share of company issued, pool top-up included | 22% |
| Series B | 18% |
| Series C | 15% |
| Series D | 12% |
| Follow-on investment by the fund | none |
Each round issues new shares worth a slice of the post-money company, and every existing holder keeps one minus that slice. Ownership at exit is the entry stake times the product of the retentions:
Exit stake = entry stake × Π (1 − dilutionround)
Exit value to return the fund = fund size / exit stake
In Excel, with the dilutions in B2:B5: =0.10*PRODUCT(1-B2:B5) (entered as an
array formula in older versions), then =100/C1.
| After | Holder retains | Fund's stake | Exit needed to return 100 |
|---|---|---|---|
| Seed | 10.00% | 1,000 | |
| Series A | 78% | 7.80% | 1,282 |
| Series B | 82% | 6.40% | 1,563 |
| Series C | 85% | 5.44% | 1,839 |
| Series D | 88% | 4.78% | 2,090 |
The four rounds together leave the fund with 47.8 per cent of what it bought. The check is immediate: 2,090 × 4.78 per cent = 100.0. Returning the fund three times from the same company needs 6.27 billion.
The fund can defend its stake by investing its pro rata in later rounds. Taking full pro rata through the Series A and B keeps 10 per cent until the Series C, and the stake at exit becomes 7.48 per cent: the fund-returning exit falls to 1.34 billion. Defending all the way to exit keeps 10 per cent and brings it back to 1.0 billion, but at a cost in reserves that a fund of this size can afford for very few companies.
| Policy | Exit stake | Exit to return the fund | Proceeds from a 2,000 exit | Multiple of the fund |
|---|---|---|---|---|
| No follow-on | 4.78% | 2,090 | 96 | 0.96× |
| Pro rata through Series B | 7.48% | 1,337 | 150 | 1.50× |
| Pro rata to exit | 10.00% | 1,000 | 200 | 2.00× |
A 2.0 billion exit, a landmark outcome for any company, fails to return this fund on its own if the fund never followed on. A 1.0 billion exit returns 47.8, or 0.48× the fund. That is the arithmetic behind the power law: a fund needs a small number of very large exits, and needs to own enough of them when they happen.
| Entry stake | Exit stake | Fund of 50 | Fund of 100 | Fund of 250 |
|---|---|---|---|---|
| 5% | 2.39% | 2,090 | 4,180 | 10,451 |
| 10% | 4.78% | 1,045 | 2,090 | 5,226 |
| 15% | 7.18% | 697 | 1,393 | 3,484 |
The required exit scales with the fund and inversely with ownership, so the two move together: a fund two and a half times larger needs two and a half times the ownership to keep the same bar. A 250 million fund buying 5 per cent stakes needs a 10.45 billion outcome per fund-returner, which is the quiet reason larger funds push for larger stakes. The dilution path matters as much: heavier rounds of 25, 20, 18 and 15 per cent leave 4.18 per cent and push the bar to 2.39 billion; a company that raises lighter rounds of 20, 15 and 12 per cent and stops after the Series C keeps 5.98 per cent and needs 1.67 billion.
Dividing the fund by the entry stake. Ten per cent of a 1.0 billion exit is 100, so the deal "can return the fund at a billion". It cannot: on this dilution path the answer understates the bar by a factor of 2.09. The second mistake is forgetting that at a modest exit the preference stack, not ownership, decides the proceeds, so the ownership arithmetic above is only reliable for the large outcomes that return funds in the first place.
The fund you work for, with the exit that returns it, is the first of the working documents on the companion page of The Venture Capital Associate, alongside the free workbook for the reserve arithmetic. How far a reserve pool goes when every fund-returner needs defending is worked in how many companies a reserve pool actually defends.
A single portfolio company whose exit proceeds alone equal the fund's committed capital. For a 100 million fund holding 4.78 per cent at exit, that takes an exit of about 2.09 billion. Because most venture investments return little, funds are built around finding and owning enough of a small number of these outcomes.
It depends on how many rounds the company raises and how much each one sells. On an illustrative path of 22, 18, 15 and 12 per cent issued at Series A to D, a seed investor keeps 47.8 per cent of its stake: 10 per cent becomes 4.78 per cent without follow-on investment.
Yes. In an illustrative 100 million fund, taking full pro rata through the Series A and B lifts the exit stake from 4.78 to 7.48 per cent, cutting the fund-returning exit from 2.09 to 1.34 billion. The follow-on cheques come out of reserves, so the fund can only do this for a few companies.
This article is one calculation from The Venture Capital Associate. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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