Hi,
Welcome (back) to MWAVC, a newsletter about finance, investing, venture capital and all that jazz. My name is Ato (more about me here and here) and I try to write every single day. Most of it is stuff I find interesting that I’d like to share and hear your thoughts on. If you’d like to sign up, you can do so here. Or just read on.
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After a long hiatus, I’m back. First 75% of the year went by pretty quickly but I got a chance to focus on what I should be working on — really helping out with my portfolio companies and digging deeper into the venture capital and private equity world to figure out my space and where I can make the most impact. Seeing how most (if not all) the companies I’ve made angel investments in are rapidly growing, I began conversations about their subsequent fundraises. A couple will be raising towards the end of the year and as I’m all about helping the people around me make money, I pitched them on putting together syndicates to invest towards their fundraise. So I’d like to invite whoever is a reader of the newsletter and would like to be part of these syndicates to register here. I’ll send out memos as and when I find interesting deals, and book a large enough allocation for me to invest, and bring some of my good friends along too. I’m looking to close out 5 transactions before the end of the year. One already closed, so 4 more for Ato. Looking forward to having you as part of the team!
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First things first, please check out this profile my brother, Jeph did on me for his Substack. You might learn a couple more things about how I think/ .operate. Next, is your startup venture-backable? Important to understand the game before you get into it. Check out the thread below from Luke Mostert at Future Africa.
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I’ve reviewed over 3000 African startup pitch decks in the last 4 years. The most important question I ask myself each time is.. ⬇
‘Is this startup Venture Capital ‘backable’?’
You see, VCs like to talk about ‘grand slams’, ‘moon shots’, or ‘fund returners’. These terms aren’t just trivial jargon, but rather a necessity for VC funds to be successful:
• For example, in 2012, Y Combinator calculated that 75% of its Fund’s proceeds came from just 2 of the 280 startups it invested into – 0.7%!
It’s this exact phenomenon that Sebastian Mallaby coined as the “The Power Law” in his book by the same name:
Opposite to a normal distribution curve, The Power Law distribution sees 10% or less of the inputs (in this case startups) bringing about 90%+ of the outputs ($ returns), as seen in the image below.
But what does this really mean for startup founders pitching to VCs?
At a minimum, it means funds would like each startup they invest in to have the potential to return their fund. Here’s how this plays out at a Pre-Seed Fund like Future Africa:
Let’s assume a VC Fund is $10M in totality, then every investment must have the potential to return at least 1x the total fund size, thus $10M.
And let's assume on each deal the fund invests $200k in the Pre-Seed round at a $5M post-money valuation.
• This means the 200k needs to multiply in value 50x to return the Fund (200k * 50 = $10M). But one also needs to factor in dilution..
• 3 additional fundraising rounds (Seed, Series A, Series B) will each add dilution of ∼ 20% to existing shareholders. So instead the investment’s exit valuation must reach a multiple of 50 * (1.2)^3 = 86x in order to accomplish the ‘fund returner’ goal.
In monetary terms, this means:
• $5M post-money * 86x multiple = $430M exit value
If we extrapolate, a software business is typically valued at 10x its annual revenue, hence the startup would need to reach $43M in revenue per year. There should thus be a path to $43M annual revenue within a VC funds (usually 10 year) lifespan:
• For instance, if the startup sells software subscriptions to businesses for $1000 per annum, is there a clear path to 43k customers?
More granularly, at what intervals (growth rate) does the no. of users have to increase each year in order to achieve this?
Is this rate of growth possible? And how probable is it? Here is where 3 other core considerations (outside of the above ‘Data’) come into play, namely:
• The Founders (Talent)
• The Product (Design)
• Scalability (Distribution)
All of which are outlined aptly in most pitch decks; however, ultimately, if a founder can’t demonstrate that their startup is – first and foremost – capable of generating a VC level return, then they will likely struggle to maintain investors' attention for the rest..
If you found value, please share for visibility 🚀
P.S. Shout out to Augustin Sayer who astutely laid out similar math to what I’ve used here.
Sign up to my cousin Yasbo’s newsletter, ChopLife Express btw AND listen to her podcast, Savings or Current. She’s already been dropping some serious gems, including this one on time management and this one on how the economy works.
Also, Afrobility Podcast is exactly what you need to be listening to for the deep-dives into Africa’s most note-worthy companies.
Recommended Substacks: Afridigest by Emeka; African Entrepreneurship Series by Jeph; Getthebrief by Loye and Fola.
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📱📱Quote of the day
“Price is what you pay, value is what you get.”
Remember: “Until the lion learns to write, every story will glorify the hunter.”
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