Pitching investors is part art and part science.  The goal here is to make the science part well understood, dissected and discussed. The good news is there is real learning to be had after giving and getting about 1000 different investor pitches over the past 10-15 years.

One of those lessons is the benefit of asking questions of the VCs themselves.  It’s hard to switch from pitch/sell mode to asking tough questions and putting yourself in the mindset of a buyer – which you are: you’re shopping for cash with your start-up’s equity.  And it’s never been more important to understand the VC business, the fund, and the attitude of the firm that you are going to partner with on your start-up.

And remember that VC firms are (almost always) partnerships which means that, in general, it really helps to have broad consensus across the partnership that an investment should be made.  To the extent that there is not consensus, the partner wanting to do the deal will have to “do work” to convince the other partners. These questions should help you understand how inherently aligned you are with a particular firm.

With all that in mind, below are a set of questions (and associated explanations) that you should consider asking both BEFORE and DURING a VC pitch.  They’re all “fair game” and none should be considered too invasive by any good VC firm.

Questions to ask before a meeting

Who will you be meeting with?  Associate?  Partner? General Partner?

Especially in larger firms, there is a well-defined hierarchy that is important to understand because of the analysis and decision-making processes within VC firms. General Partners (GPs) are the most influential decision makers at a firm, Partners are a notch down and associates are typically the entry-level position in a firm.  Of course, the goal would be to meet with a GP if at all possible; that said, it’s unfortunately uncommon to get a firm’s GP in a “first meeting.”

Many times, associates proactively reach out to companies in specific market segments and start-ups in a particular category; they also do much of the front-end company and deal analysis.  The one sentence summary is that they can say “no” but rarely can say “yes” when it comes to their firm making an investment.

Quick sidebar:  how to handle inbound calls from a VC firm

Some firms have a staff dedicated to outbound calling every company in a particular market segment for the purposes of generating market research, analysis and deal flow.  When your start-up receives a call “out of the blue” from a VC firm – this is probably what’s happening.  Don’t be overly flattered because you’re probably one of 25 companies that have received a similar call.

First, ask who you’re talking with and their title; ask why they’re calling and who else they’ve called.  Second, don’t feel obligated to give out any information that you wouldn’t give to someone cold-calling from Techcrunch or GigaOm.  Finally, if you’re in the process of raising or thinking about it soon – tell them and ask to set up a meeting with a larger group or to meet in person the next time you’re in their geography.  No decision will be made on this basis of this first call…so more exposure to a broader group is the goal.

If the firm is reluctant to set up a follow-on meeting – then they’re probably just investigating at this point – don’t waste any more time with them.

What is the firm’s investment focus? Market segment?  Geography?  Stage?

Some firms focus on particular market segments or specific geographies.  Some firms want to be the first money in a deal and others only invest after the first “one million dollar quarter” as been achieved.  Inquire as to the firm’s focus when it comes to market segments and stage of company.

It is common for a VC firm to prefer to have a “local partner” when they’re investing in a geography that is a plane flight away from their home offices.  This is a form of “security blanket” for the out-of-town investors because they know that a local investor partner would be able to help the company more frequently.

Clearly, if they are not focused on your market, geography or stage, it may not be worth your time to meet with that particular firm.

Are there related investments? Competitive? Complimentary?  Partners?  Acquirers?

This is a logical follow-on question if the firm likes and invests in your market segment.  They may have a competitive or complimentary investment that are important to know about before you pitch.   At the very least, this will tell you how familiar the firm is with your market – which can make your pitch MUCH more focused and detailed because they already have the market context.

Clearly, if the firm has a competitive investment, it’s probably not a good idea to meet.

Do you lead?   Do you follow?

This question is really simple but very important.  If the firm you’re pitching doesn’t lead, you’re not done even if they want to invest.  A lead investor prices the round, sets the terms of the deal and generally makes the majority investment for that financing.  Many firms are happy to lead the investment – but some don’t.  And you need one in order to raise this round of financing.

Similarly, some firms won’t follow other leads. In other words, they want to be the lead investor for one reason or another.  There are always exceptions to this rule but understanding the firm’s basic philosophy is helpful. This particular philosophy is usually related to the ownership a firm targets for each investment (see below).

Questions to ask during or after the pitch

How much time do I have?

Always a good place to start; you may get a couple of different answers based on how many people are in the meeting.  In general, I suggest you pitch to the time frame of most senior partner and use any remaining time with anyone who has more time to fill in details and context.

What is a typical investment size?  Do you have a target ownership percentage?

This is related to the next question (fund size) and a good way to calibrate the potential fit with this investor.  Depending on fund size and the firm’s investment philosophy, there will be a minimum (and maximum) amount of money that the investor targets for each deal.

Understanding how much of your company the VC needs to own to make their business work is really important information and very related to whether they lead and how much they can invest.  In terms of ownership targets, most firms want to own 20% – 33% of a company in the fullness of time.  That means they don’t have to achieve that level all at once but expect to be able to invest to that level over time and potentially other financings.  While firms will tell you that this is never a binary decision point, it’s true that not achieving these targets make the investment much more difficult to get through a partnership.  There are some firms that don’t have target ownership percentages; also, angel investors almost never have such targets.

How big is the fund that you’re currently investing out of?    When did you raise it?

This is simply calibrating how much “dry powder” the firm has on hand.  Big, new funds have different dynamics than small or older funds.

Funds typically have a 10-year life span with new investments being made in the first 3-4 years; if the firm you’re talking to raised it’s last fund 8 years ago, it’s an older fund with less probability of supporting new deals…and the next few questions are really important.

How much have you invested out of that fund so far?   How many deals is that?

This will tell you what’s really left in the fund. There are issues with both “brand new” funds (such as new capital calls and when investments can start taking place) as well as with funds that are so old that they basically must be kept in reserve for companies the firm has previously invested in.   “How many deals” gives you a sense of how much capital they typically put to work per deal…which is a fine question to ask directly (see above). This also gives you a sense of the firm’s over-all volume.  A very low volume means that your company really needs to line up with the firm’s core domain/interest or there is likely no deal to be had.

How many deals have you done this year so far?   How many do you expect to do?

This is related to the previous question but starts to consider the firm’s behavior in the current environment…and this is where it starts to get interesting.  If the firm does x deals per year and they’ve already done that many, then the investor is really going to need to love your start-up to justify a higher volume than their firm was planning.

How long do you think it would take to close this round if we started today?  And would you anticipate any unique “conditions to closing” for this deal?
Closing typical rounds of financing takes time; and, in general, the larger the round, the longer it takes. Even in the best situation, 60 days would be considered blazingly fast.  Today, honestly, 3-6 months isn’t surprising. There are many standard conditions to closing a round of financing, such as due diligence.  However, this question is trying to get at whether or not there are conditions that might make the financing more difficult than usual. For example, does the VC require another venture firm to participate in the round?  Does the VC require some significant new customer traction before being ready to fund?

What other firms / individuals do you like investing with?

A syndicate (the set of venture investors in a single round of investment) adds complexity to any round of financing AND the go-forward board and outcome dynamics for any company.

That said, finding out what other firms this VC likes to invest with in a syndicate is a great way to do two things: first, you find out who you should go talk to next.  And don’t forget to ask for an introduction to whoever comes up after asking this question.  Second, it is increasingly important to make sure you have a set of investors that get along and have history together. As your company executes through typical challenges, venture firms will be forced to make decisions around their portfolio, funds, and strategy. Trying to ensure that you have a set of investors who have a good relationship and have worked together on other deals can de-risk the negative effects of diverging investor/firm agendas.

…more questions and updates as I can think of them.

It’s interesting that, really, only Amazon is still innovating and would qualify as a serious “brand.”  And of course, this is before Amazon could spell PUBLIC CLOUD.  Also interesting that I don’t ever think of a company as a Internet or non-Internet brand these days.  If I recall correctly, Netscape is already part of Yahoo! at this point in time (June 2000) so we’re talking about a 4 companies…3 of which are largely in decline these days.

Here’s another fun chart:  Global Internet User Growth:

The chart below shows the actual Global Internet user growth (blue) compared to the predictions (red) in the chart above.  It great that, despite being very bullish, the MS forecast was low by about 36% by the end of 2004.  …so let’s see: in (more or less) one decade, the dominant companies crumble or are in serious decline and adoption far outpaces the most bullish projections.  Even if we guessed that the big players of 2000 would wane, could we have predicted Google or Facebook?  What would have been done differently if we all knew that more than 2 billion folks would be online in a dozen years?  thoughts?

 A couple obvious things worth pointing out: first, this was only 12 years ago.  A little more than the average life span of a typical VC fund; basically just a decade ago; really, the blink of an eye.  Second, this was really interesting timing relative to what was about to happen to the tech industry and stock market. One of the main analysts was Mary Meeker (now at VC firm  Kleiner Perkins).

The chart below shows the NASDAQ run-up leading to March of 2000 where we hit an all-time high of just over 5000. Today, of course, we’re trading about 2700 up from a low in October of 2002 of 1139.  So, really, this report was published just before the crash of 2000-2002 (everyone tends to remember it as just 2001).

If nothing else, it’s amazing how quickly things can change. That’s a great lesson for start-ups (and large companies).

so…in the spirit of learning from the (recent) past and in the spirit of having some fun, I’m going to pull some choice bits out of this research over a few posts in the coming weeks.  I might even scan some of this stuff in and post it if there is interest.

Remember:

• this was before Google
• this was before broadband was ubiquitous
• this was when AOL and Yahoo! were kings

fun stuff to follow… see?  good thing I didn’t throw it away.

Knowing when to bring experienced management talent into a young company is a subtle, yet critical decision point that almost all successful companies will pass through in their lifetimes.

In the early days, with little or no revenue traction from their products, start-ups can benefit from having a scrappy culture and a flat organization obsessively focused on delivering a compelling value proposition to their customers.  At Silverton Partners, we work with early-stage companies and tend to favor entrepreneurs who have a “lean start-up” mentality.  We believe the discipline of having to make hard decisions about where and when to allocate resources builds better, more capital efficient companies.

Maintaining an overly lean mentality as the company scales up can, however, have drawbacks.  As early-stage start-ups execute well, their success brings added complexity to the business.  If these new challenges are not adequately addressed, the company’s ability to continue to grow can be seriously inhibited.  It is around this time, when the founding team may need to consider bringing on an experienced executive to help take the business to the next level.

What sort of help executive help do I need?

The answer to this is different for each business.  Complexity arises in a number of forms, including the need to hire an increasing number of people, build out the required infrastructure and business processes, supporting and on-boarding larger numbers of new customers, generating more detailed financial reports and forecasts, as well as other issues.  In our experience, many of the new challenges that arise within a growing start-up, including those listed above, fall into the finance and operations area.

When is the right time to invest in such expertise?

All too often, management teams wait until issues surface and things start to break before they seek help. And when a hire is finally made, it is often too junior.  This can happen because the company is hiring for its current needs and existing budget instead of making a hire to address where in company will be in 12-18 months.  In a rapidly growing company, that can mean disaster or, at the very least, it means the company is not as well prepared as it could have been.

Here are a few scenarios that suggest your start-up might need to bring an experienced executive on board.

Your company must scale multiple business processes simultaneously

The company’s customer traction has caused an implementation and support backlog that must be scaled simultaneously with limited budget to avoid jeopardizing the company’s credibility and reputation with customers. The company is bringing additional products or services to market that require different sales motions or have different support requirements. The company is acquiring a technology or another business which must be integrated and operate without disrupting every-day operations.

Your company requires a more mature financial function

The company’s product traction is driving increased revenue and your revenue recognition policy is undefined or unclear; implementing the wrong policy today becomes increasingly difficult to correct as time goes on and the company continues to execute.  The company must perform a financial audit without disrupting the business. The company must develop an operational plan that extends further into the future than you have planned for in the past; here, any forecasting error has material impact on the businesses’ decision making and, in some cases, viability.

Your company’s audience expands

At their start, companies only have employees to manage. Then investors are added to the mix and eventually a few customers are won.  As the company grows, its audience will likely expand to new board members, new investors, investment banks, commercial banks, formal Fortune 1000 customers, channel partners, potential acquirers and others.  Who should get what information?  What is the proper messaging and presentation of information to demonstrate that the company is a professionally operated business?

The company wants to “future-proof” certain operational scenarios

Is an acquisition is likely in the next 18 months?  Who will be interfacing with the legal teams? Are you fully prepared to go through due diligence?  If so, is the company going to have IRC Section 280g / 4999 / golden parachute issues as a result of an acquisition?  Not sure what that means?  Well, that’s the point.

Is the company selling to a Fortune 1000 customer that requires financial due diligence to be completed prior to allowing business to be done?  In order to look credible, what is the right amount of information and in what format? How do you handle confidential information? How do you negotiate the contract that is they have said is non-negotiable?

Does the company’s sales compensation model not only incent the proper behavior today but scale well in the case of unexpected success?  Are there scenarios that create business-limiting liabilities or revenue recognition issues?  Does the compensation model pay out at the right time such there are no working capital issues and customers have accepted the product?

Why senior is better

An experienced executive knows many of the traps and pitfalls that young companies get into and can help prevent them proactively.  Employing more junior talent may help solve today’s problems at a bargain price, but could create larger problems in the future that must be solved in a reactive and more costly manner.

In the end, the exact right time to bring in financial and operational expertise depends on the company and its particular circumstance.  Without question, it’s hard for a young company to see around corners that it doesn’t know exist.  However, what remains universally true is that by the time it becomes obvious that an experienced CFO/COO’s expertise is necessary, it may already be too late.

• active planning cycles in many of Silverton’s portfolio companies
• growth targets and revenue scale discussions in those same companies
• reading Fred Wilson’s post on the dearth of start-up exits above $100m http://kipm.cc/qtwwas
• thinking about the details & drivers of past acquisitions of my companies (for example).

We need more companies that have a vision for building real businesses that scale to produce more $100m+ exits (not just $100m+ valuations).  As an investor, I’m generally less interested in the sort of pre-product or talent-based acquisitions that have become popular at places like Google, Twitter and Facebook because it takes the team out of the game and keeps their vision — the one that I invested in — from being realized. I believe that a $25m-$30m annual run-rate means that the company has a long-term perspective and executed well enough to have options:  stay independent and (likely) profitable, be an attractive acquisition target or even consider an IPO.

But let’s talk about acquisitions. For acquisition targets with revenue, acquirers tend to value acquisitions as a multiple of revenue that increases based on how strategic the business is to the acquirer and the potential leverage of the business model for the acquirer.

For example, for a business with lower strategic value to the acquirer, multiples tend to be 1x – 3x forward 12-month revenue.  For businesses that have less business model leverage (such as low-margin, services-based company that requires a significant human component to scale), the multiple could even be less than 1x forward 12-month revenue or, where possible, simply valued as a multiple of EBITDA.

For businesses that are highly strategic to the acquirer, multiples go up significantly.  3Com paid an ~11x multiple when they acquired TippingPoint because they wanted to get back into the large-enterprise IT space and wanted to do that via a high-margin security product.  TippingPoint’s cutomers were exclusively in the global 2000 and we had a world-class security product. TippingPoint was at a ~$38m annual run rate and therefore had sufficient traction to prove that customers were repeat buyers and referenceable.  BroadJump achieved around $50m in revenue in three years with about as much in backlog.

Once your company clears the $25m+ annual revenue bar and an acquirer has assessed the strategic value of your business, the following criteria will drive that acquirer’s valuation analysis:

1. revenue concentration risk.  if you company achieves revenue scale through (to be extreme) a single, $6.25 million dollar deal each quarter (aka “elephant hunting”), the revenue concentration risk will discount your multiple.  More transactional businesses where many smaller deals make up your revenue drives a higher multiple because losing any one deal won’t de-rail your quarter.
2. revenue consistency.  Hitting your revenue target one quarter and missing the next will obviously discount your appeal (and multiple) to acquirers.
3. time to scale.  As a general guideline, if a company achieves $25m in revenue in less than 4 years, it’s a defacto a high-growth company with good execution. Conversely, if your company has been around 8 years and has yet to achieve such critical mass, both investors and acquirers will (at least) wonder what’s wrong with the business.

Given the above, if your company is a reasonably strategic acquisition target, executing well, with at least a $25m revenue run rate should deliver an exit over the $100m mark because your multiple should be more than 4x the current annual revenue run rate.

Let’s assume we’re talking about a software product company.  Whether you price and sell your product on a monthly basis, you can certainly do the math to understand the revenue it delivers on a per-month basis.  Therefore, the very first observation is that your product’s selling price has a huge impact on how complex it will be to scale your business. A product that delivers $100 per month will require nearly 21,000 customers to achieve $25m annually; a $10,000 per month product will take (only!) 208 customers. For what it’s worth, I think the most resilient, scalable software businesses charge somewhere in between these two monthly goal posts.

Starting from ZERO-revenue, your start-up will progress through several phases on your way to $25m annually…which is $6.25m quarterly…which is about $2.1m per month.  As the business passes through these phases, more and more of the business is understood and infrastructure to scale is put in place.

The five phases of revenue scale & what they mean:

Phase One:  $0 — the first sale or two

• the company starts to prove it can build a complete product
• it proves that you can twist someone’s (mom? dad?) arm to become a “customer”
• it proves that you’re not unrealistically priced (although you may be leaving money on the table)
• phase one is the beginning of measuring conversion, activation and on-going activity rates

Phase Two:  getting to the first dozen sales

• entering this phase, the the company has achieved some degree of product-market fit but it is still learning something new with each sales transaction
• it proves the company can stick to their product and sales plan but says nothing of how good those plans will be in the long term
• the company can to begin to characterize the cost to acquire a customer…but not yet able to characterize cost to serve this market.  cost to serve = cost to acquire + support + keep active (and therefore remain the customer)
• in phase two, the company has yet to prove that it can really scale sales and the sales motion is most likely “brute force” with little repeatability

Phase Three:  getting to $1m per year

• entering this phase, the company has generally proven product market fit and, consequently, the list of next “critical” features to add will be a mile long thanks to customer input
• it proves the company has started to scale sales and characterize cost-to-serve at this level:
• the company has a defined and repeatable “sales motion:” a fully direct sales force, lead gen + an ISR (inside sales rep) team, or touchless via leads and web-based transactions.
• data-driven understanding of where to invest to grow sales and revenue
• the customer or buyer is well understood… And therefore messaging should be mature at this point
• the company should have knowledge of market trends such as seasonality and other buying behavior such as multiple decision makers and sales cycle lengths
• it proves that the company is measuring and improving conversion, activation and on-going activity rates as part of daily business.
• phase three is the first meaningful revenue milestone for a start-up and its investors.

Phase Four: getting to $1m quarter

• Entering this phase, the company has reasonably proved that you have a scale-able business (versus being able to scale small sales process in Phase Three)
• it proves that the product is differentiated enough to beat competition consistently
• it proves that you can maintain reference-ability and keep customers (since getting here will typically take longer than a year…which is usually the maximum amount of time between customer re-commits)
• it proves some financial discipline and that there is leverage in the business model (ie you don’t have to perpetually spend a dollar to make a dollar in revenue)
• in phase four, the company is typically leaving the “early stage” and maturing into the “growth” phase; profitability is usually possible around Phase Four; and while profitability may be possible, maintaining it will challenge rapid, sustained growth at this level

Phase Five: getting to $6.33m per quarter

• entering this phase…
• the company likely has more than one product in market;
• the company has likely expanded the opportunity in existing accounts beyond the initial “deal;”
• the company has continued to beat the competition in competitive situations;
• the company has continued to scale the sales team and process to an even more mature state and know what it will take to get to $100m in annual revenue
• in phase five, the company is unquestionably a “growth-stage” business and, in general, the company should be sustainably profitable.

These five phases are at least one swag at the “stair steps” to growing a start-up from zero to $25m in annual revenue; scaling beyond $25m up is never easy but the creative requirements and range of unknown problems have generally been addressed by the time you get to $25m.

Finally, it’s interesting to remember that a clear path (or achievement) of at least $100m in annual has been the most common lower bar for IPOs for quite awhile now (although the window has slammed shut pretty recently). If you’re able to achieve $25m, I sincerely believe that you will have executed your way to a range of options for raising future capital, running a profitable stand-alone business, being an attractive acquisition target, or even driving toward an IPO. Having those options available is the definition of success.

It’s clear that the CEO’s role in a venture-backed startup is unique and critical to its success. What’s not so obvious is that the core job description — while it would be possible to roll out a laundry list of nuanced, superhuman characteristics — comes down to a few, simple things.

Before we get to those, let’s discuss two important conditions mentioned above: venture-backed and startup.

Being venture-backed means you’re using other people’s money to build your business, and that creates an obligation to build a high-value business as quickly and efficiently as possible. And the person accountable to investors for that obligation is the CEO. This is in contrast, for example, to a lifestyle business such as a local house painting company whose owner has no outside investors or desired outcome other than to provide a decent living for the few involved. A venture-backed company also has board of directors, usually made up of the founders, CEO, investors and independent industry experts. While the company reports to the CEO, the CEO reports to the company’s board of directors.

Being a CEO in a startup is an important distinction because there are different skills and kinds of experience that might be required for later-stage companies. For example, a public company might want a CEO with experience dealing with industry analysts, institutional investors and operations in different countries. An older, troubled company might want a CEO with experience restructuring and strong financial skills. A startup is a unique life stage with specific challenges and requirements for the CEO.

With that said, the requirements of a venture-backed, startup CEO fall into just four buckets:

First and foremost, the CEO must be able to hire great people and give them the autonomy they need to thrive. One common failing among CEOs in this regard is being unable or unwilling to hire people who are better at their jobs than the CEO. This is precisely opposite of the desired behavior: The most successful CEOs in the best companies hire people far beyond their own abilities. In the worst case, the CEO simply may not be able to recognize great talent.

Another failing among CEOs is not inspiring enough confidence in themselves, the existing team or the business to attract great people to the company. This is a difficult challenge to overcome and typically is the clearest sign that the CEO may be putting the company at risk. Even if the CEO can hire great people, he or she must also be willing to delegate responsibility to those employees. Being a successful startup CEO is often characterized as a process of slowly giving up control to an ever-growing team. It sounds counterintuitive, but every successful CEO figures this out at some point.

The second requirement is being financeable. Just as CEOs must inspire confidence and excitement in themselves, the team and the business to hire great talent, they must do the same with investors — new and existing ones. If the CEO can’t communicate the company vision and opportunity in a way that compels investors to continue to fund the company, that’s a big problem. To be successful, the CEO must have a mix of passion, market insight and selling skills to present the company in an articulate and inspiring way. If that sounds subjective, it is.

Third, being self-aware is critical. A typical startup learns something new about itself, its product or market opportunity nearly every day. CEOs need to know what they don’t know along with having a sense of their strengths and weaknesses. This isn’t as easy as it sounds because the CEO stereotype is a person with all the answers.

This is a trap: The CEO must be comfortable not immediately having the solution to every problem and must possess the intellectual curiosity — and humility — to find the correct answers with the management team, advisers and board members.

UPDATE to original article:  On the topic of being self-aware and CEO psychology, Ben Horowitz had a great post. I highly recommend it.

By far the most difficult skill for me to learn as CEO was the ability to manage my own psychology. Organizational design, process design, metrics, hiring and firing were all relatively straightforward skills to master compared to keeping my mind in check. Over the years, I’ve spoken to hundreds of CEOs all with the same experience. Nonetheless, very few people talk about it, and I have never read anything on the topic. It’s like the fight club of management: The first rule of the CEO psychological meltdown is don’t talk about the psychological meltdown.

Finally, the CEO needs to be the keeper of and spokesperson for the company’s strategic vision. Many successful leaders have the ability to inspire and motivate people. They are able bring people together to focus on a common and unifying purpose, which is, more often than not, the company’s strategic vision. This skill is especially critical in startups because of the risks employees undertake when they join and the uncertainty that will undoubtedly present itself during the ensuing journey.

In the very early days of a startup’s life, the CEO may not have all of these qualities, and that’s acceptable. Every CEO is a first-timer once, and learning on the job is certainly possible. But over time, these qualities are critical, and a CEO who doesn’t develop these skills puts the business at risk.

The best CEO education comes from being an active student of the position with an open mind and being aware that the job really comes down to a few key qualities.

Understanding the business model of venture capital firms is critical for entrepreneurs who want to raise money from them. How VCs make money, pay expenses and repay their investors affects how these firms operate and make investment decisions.

VCs invest in startups out of a fund — a pool of money raised from institutional investors and, occasionally, wealthy individuals. This money is committed when the fund closes and transferred to the VC firm’s account as needed to make investments. Venture funds range in size from less than $30 million to a few billion dollars. A VC fund has a life span — usually 10 to 12 years — in which the VC firm can make investments from that fund and, hopefully, have great returns on those investments.

Most venture firms try to invest the fund as quickly as they can — usually in the first three to five years — so their companies have time to grow and then exit, typically through an acquisition or initial public offering, before the life of fund ends. As an entrepreneur, knowing the fund’s age can give you an idea of how much time you have before your VC investors might want to liquidate their investment in your company.

When VCs make investments, they usually also set aside a portion of the fund as reserves to support that company’s future financing needs. These reserves are somewhat flexible and discretionary. If you are in a venture-funded company, you should ask how much your VCs have reserved for your deal because it gives you an idea about how much capital you might expect to receive from them in the future. If your VCs have little reserved, and your company needs additional capital, you’re probably going to need to find an outside investor.

Following the money

VCs make money in two ways. First, venture firms will typically take about 2 percent of their fund per year as a management fee. This is used to pay salaries, rent, travel and other business expenses. Let’s assume that a fictional VC firm has a $100 million fund. This firm draws $2 million per year to pay expenses, regardless of the how well the VC’s investments are doing.

VCs also have a performance-based element of their compensation, called “carry,” which often equates to around 20 percent of the profit from their investments. In order for the carry to kick in, the fund and all management fees must first be returned.

If our hypothetical fund returned $200 million after 10 years, the firm would repay the $100 million the investors contributed and pay itself $20 million in management fees, leaving $80 million to split 80-20 between the investors and the VCs. In this case, the carry — to the firm — would be $16 million, with $64 million going to the investors. The larger a VC’s fund, the larger the management fee income and potential carried interest compensation.

Keep in mind

For entrepreneurs, there are two important considerations. First, partners at VC firms tend to do the same number of deals regardless of the size of their fund. In general, making a small investment takes about as much time as making a large one. As a result, larger funds tend to make larger investments, and smaller funds tend to make smaller ones. Many VCs also evaluate prospective investments in relation to how much of the fund they are likely to return. VCs want to do deals that can “move the needle” — or significantly contribute to the fund’s performance.

It is important for entrepreneurs to pick VCs who do investments in the size range they need and whose exit expectations match their own. Many VCs won’t do a deal unless they think it can return at least 15 percent of their fund. For our hypothetical fund of $100 million, the VCs would have to believe their stake in a new investment could be worth at least $15 million.   So when Groupon raised $950 million from a cadre of VCs, their exit expectations for the company would be massive.

Kip McClanahan and Morgan Flager are principals with Silverton Partners, an Austin-based venture capital firm.