Seed investors really need to make 15.2x

In a recent post Fred Wilson wrote about seed investing:

“When you lose on 60-80% of your investments, you really need the ability to make 10-20x on your winners.”

Does that make sense?

Money multiple fund

Assume that a seed investor invests out of a fund.

And that he wants to make a 12-15% IRR per year on this fund.

And that he exits a startup after 7-10 years.

With 13.5% IRR per year and 8.5 years till exit, the seed investor needs to make (1 + 13.5%) ^ 8.5 = 2.9x on his fund.

Loss

Assume, like Fred, that the seed investor loses on 60-80% of his investments.

With a 2.9x money multiple on his fund and a 70% loss, the seed investor needs to price each startup that he invests in at a 2.9 / (1 – 70%) = 9.7x expected money multiple.

The seed investor needs to make 9.7x on each startup that he invests in. Not just on his winners.

Dilution

Assume that each startup raises 1-3 follow-up rounds.

And that each round buys 15-25% of the company.

With 2 follow-up rounds and 20% new shares per round, the seed investor will dilute 1 – (1 – 20%) ^ 2 = 36%.

With a 9.7x expected money multiple and 36% dilution, the seed investor needs to price each startup that he invests in at a 9.7 / (1 – 36%) = 15.2x money multiple.

So

If you believe these 3 assumptions then Fred’s “when you lose on 60-80% of your investments, you really need the ability to make 10-20x on your winners” makes sense.

“When you want to make 2.9x on your fund, lose on 70% of your investments and dilute 36%, you really need to price each startup that you invest in at 15.2x” makes even more sense.

Joachim Blazer is author of The #1 Guide to Startup Valuation. How to value your startup in 12 easy steps. For founders. For seed rounds and Series A. For equity and convertible debt.