Venture Capital

Term vs. Perpetual Licenses

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One of the interesting trends we’ve seen in the markets over the past few years is the large premium paid in the public and private markets for recurring revenue business.  Knowing that people are paying more for term, there has to be fundamental financial reason. There is.

Tldr (or for those unfamiliar with the internet – “Too long, didn’t read”)

The short answer: in a term business investors assume that the Company will generate more money over the lifetime of the customer by charging higher annual fees, rather than a large upfront payment and only a small recurring maintenance contract.

The long answer

As a reminder – a perpetual license means you pay once for the license and own it forever.  Most enterprise licenses include a maintenance contract that entitles the owner to support and updates to the software as long as they own it, for approximately 20% of the total cost of the contract each year.   A term license is the right to software for only a fixed term, in most cases a one or two year timeframe.  Every year, the buyer has to pay the annual fee again, but constantly gets updates and support.  Typically a term license is priced to be equal to a perpetual license over three years.

Here is an excel model that plays out those two business (Click here to download) – a perpetual business and a term business (download it and play with the assumptions by changing a blue cell).  The total cost of ownership over three years is $1680 in both pricing scenarios (perpetual – $1200 year one, $240 year two, $240 year three; term – $560 per year).

I assume strong growth in both scenarios, with the same number of widgets sold each year.  The trend you will see is that the recurring component of sales is much higher in the term business.  By year 5, the Company is generating more money from existing customers than from new sales.

What is really interesting is when we look at the value of both business based on current public comps (I list the comps on the second tab that I used to find the median EV/TTM Rev).   Applying the current market multiples to both business, you will see that in first few years, the enterprise value of the businesses are about equal, but in the last few years, the term business’s enterprise value is higher.

Summary

So what?  Both business models have their benefits.  Perpetual models generate cash much faster (most of the total value is paid in year one), while term licenses collect equally over three years.  The key, is that in year 4 that term license is paying the same $560, while the perpetual deal would only get a maintenance payment of $240.  Term is up $320 per license.  As long as a customer pays for more than three years, a term model is better.  That’s why people will pay more for the same business selling the exact same number of licenses in a recurring model.

Return of the Jedi

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So, we get it.  Companies raise money, they need to set a valuation to raise said money, and they sell some of the business to raise that money (money, money, money).  There are some important things to understand in the fundraising process, and there isn’t enough time to cover them all, so I’ll stay on the ones I think are important.

Signaling

Raising money is very much so a marketing move.  There is (hopefully) positive press that can come from a capital raise.  When you raise money and announce your valuation, that sets expectations in the market – namely it shows what investors think the business is worth today.  It also figures into what investors think it COULD be worth in a few years.  Venture investors target a 3x to 5x multiple of their money in any given investment.  Generally, that means the business needs to sell for three times the amount of the last round.  So, raising money at a $250mm valuation suggests that the business should be able to be sold for between $750mm and $1.25B.  That is a lot of money.

In addition to the signal and expectations from a valuation, the existing investors’ involvement in each round matters.  If a venture investor invested in the Series A and Series B rounds, but doesn’t invest in the Series C, it doesn’t look so good.  It typically signals that the venture firm has less conviction in the future prospects of the business.  Some seed funds and early stage investors will not typically continue investing for the entire lifecycle of the business, but usually investors continue to fund a business if they think it will be successful.

Pro-Rata

This concept of continuing to support a business is demonstrated in a cap table through pro-rata investments in subsequent rounds of financing.  That is investor speak for putting up your fair share of the next round of equity.  There are a few ways to calculate what “pro-rata” represents (either your share of a future round of investment or the amount required to maintain your ownership percentage in the business).  There is a great post on Brad Feld’s blog here about pro-rata if you are interested.  Not even all VCs agree on what “pro-rata” means…

Liquidation Preference

In a standard venture deal, there is a concept known as a liquidation preference (again, covered by Brad Feld well here).  The liquidation preference is a set amount of capital that the preferred shareholders (venture investors receive preferred shares in a business with each investment) receive in preference (i.e. BEFORE) the common shareholders.  Founders and employees of the business receive their shares in the form of common shares.

This means, when the business is sold, those investors will receive a set amount before the common shareholders.  Typically, there is a 1x liquidation preference (meaning 1x the amount invested, so a $5mm capital raise will include a liquidation preference of $5mm).  There are two ways to calculate what this means: Participating Preferred Shares and Non-Participating Preferred Shares.

Participation

Non-participating shares have a right to receive either their liquidation preference OR their fully diluted ownership percentage.  Participating shares receive both their liquidation preference AND their fully diluted ownership percentage.  Let’s use an example to show how this works.

Assume that HotStartup raised one round of financing equal to $5mm at a post-money valuation of $20mm (meaning they received 25% of the business), with the founders retaining the remaining 75% of the business in the form of common shares.  In any sale of the business for less than $5mm, if there is a liquidation preference – the preferred shareholders would receive all of the capital.  If the business sells for more than $5mm, there are a few different outcomes.

If the shares are participating preferred shares, in a sale of HotStartup for $30mm, the investor would receive the first $5mm (their liquidation preference) AND 25% of the remaining $25mm ($6.25mm).  The investor would return a total of $11.25mm, with the founder getting only $18.75mm.

If the shares are non-participating, the investor has the right to EITHER the liquidation preference OR their ownership percentage of the total sale.  So in our last example, they would get EITHER their $5mm liquidation preference OR their 25% of the $30mm ($7.5mm).  Obviously they would take the $7.5mm, leaving $22.5mm for the founders.

The difference between participation and non-participating shares is huge (in our simple example, the difference between $3.75mm!).  Despite this, I have encountered countless management teams that do not know if the investor’s shares in their business are participating or non-participating.  For reference, according to PitchBook, 60% of rounds in 2013 were non-participating, with 30% have uncapped participation and 10% have a cap on the participation (meaning a limit to the amount that the investor may receive both their liquidation preference and ownership percentage).

There are TONS of nuances within a term sheet, and I highly encourage every founder to have an experienced lawyer look through the terms of a deal on your behalf.  There is too much that can be slipped into a term sheet and the legal documentation, all of which can have an enormous impact on the potential economics.

This was a long post, and was one of a three part trilogy (part one here, part two here).  There is a lot involved in a capitalization table, and even more nuances in the legal documentation.  There is no harm is asking for help, there are tons of resources, and lawyers are always available (at their normal billable hours…).  Don’t sign a contract unless you know what it means, it could cost you literally millions of dollars.

The Empire Strikes Back

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The second stage of the Cap Table Trilogy, The Empire Strikes Back (really no correlation to the Star Wars Trilogy, but I like Star Wars, so we’re sticking with it).  At this point, HotStartup has built an amazing product, we’ve figured out our business model, and we are starting to really scale.  $5.5mm has been invested by some great VCs and Seed investors.  Time for that Series B.

Series B

This is the time to get some real money.  We need bigger investors who are looking for the next three to five years, with some deep pockets.  The investors skill set at this point isn’t focused on business models and early stage operations, but truly has a grasp on how to scale, and scale fast.

Thinking about HotStartup, we MAY have generated a couple million dollars of revenue in the last twelve months, but we are likely somewhere around that $5mm to $10mm range.  In order to start really being interesting to a potential acquirer or to think about going public, we need to hit a minimum of $50mm.  Growing by 10x in 5 years means we need to grow 59% annually – that’s a LOT.  Big growth needs big dollars.

Valuation will also increase with this raise, and hopefully quite a bit.  Thinking about the multiples, if we were able to generate somewhere around $5mm, a pre-money valuation of $25mm (5x revenue) would be fair.  Including the $10mm ask, we would be at a $35mm post-money valuation (7x revenue), something that is within reason.  This raise represents a 28% sale of the equity, and will dilute all the prior investors (remember, we assume no participation from old investors in new rounds).

Series C and Series D

Here is where things start to reach more normal, reasonable multiples for business.  Things are based on the revenue of the business and the performance.  We get a lower premium based on our potential, and a larger premium based on our business.  Customers should be adopting the product, buying lots, and really NEEDING our product.  Without HotStartup, the Fortune 500 would fall apart.  We’ve spent $15.5mm on the product and are starting to scale at more than 50% annually.  Let’s step on the accelerator, throw gas on the fire and really blow this out of the water (generic business terms always make you sound sophisticated, and are never a bad choice).

We need some serious cash to invest in the sales and marketing department (S&M).  Research and development (R&D) are important, and should keep up with the innovation cycle in our business, but we already have a fully functioning product that is performing in the market.  We won’t spend less on innovation, but we likely aren’t growing the R&D budget at 100% annually anymore (every busines is different, so I wont say that all business slow down their spend on R&D, just making an assumption from my experience).  General and administrative (G&A) costs should start to be leveling out, as we should have a C-suite in place (or will have a C-suite in place post-Series C).  We either retained the founder as CEO, or brought in a serial entrepreneur that knows the space; the CTO is one of the founders and is leading the product and innovation; a CFO is helping manage the equity partners, board members, banks, financial planning, audits (you know, the fun stuff!); and the COO is making sure the place isn’t falling down, keeping the business partners in-line and making sure our amazing product is always delivered the way it should be.

We’re investing to grow the business.  Each dollar we invest will add to the growth of the business, and hopefully we can measure how this works.  In a recurring revenue model there are lots of great financial metrics we can use to measure our performance (ARPU, AMPU, CAC, CLTV, Churn, etc.), making it easy to understand why investing $20mm of cash into a business that is spending $5mm to $10mm a year is totally logical.  I promise venture investors are not dumb; there are always metrics that justify the investment.

So, what does this all mean for HotStartup?  Well, we are going to need to balance our cash needs a little more carefully now.  If we take a LOT of money in the Series C, we will be taking on dilution and cash at a time that we might be able to spend it as quickly as we would like.  If we wait to take cash, we might miss an opportunity to grow the business at the exponential rate we need and wont maximize the value of the business.  Here is where the financial expertise of a good CFO really matters, this is when we can start to really explore bank lines, venture debt, tranched equity raises, convertible equity notes, follow-on invetments, vendor financing, etc.  For the purpose of understand how to build a cap table, I’ve put together some assumptions around valuations and capital raises based on the PitchBook VC fundraising report from Q4 2013 (embedded below as well).  There are a TON of great insights in there regarding the valuations of business, investor rights, and standard terms.  I encourage everyone who ever thinks about raising money to look in there and see what the REAL industry averages are for potentially expensive investment terms (which we will cover in the next section).

After all of the capital raised, and all of the money invested into the business – we as founders would own ~26% of HotStartup.  That is really, really good.  As one of two co-founders with 80% of that amount, we would have 10.6% of the business, worth $16mm at a $152mm post-money valuation.  Not bad, but you know what’s really cool? A billion dollars (in my most sly JT as Sean Parker voice).

Seed through Series D Cap TablePitchBook_4Q2013_VC_Valuations_and_Trends_Report

A New Hope

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Preamble: Like all great Hollywood franchises, The Cap Table will be a trilogy.  I can tell already, you are on the edge of your seat in suspense…  There are a ton of valuable insights and important signaling events that a cap table represents, so I want to make sure I touch on everything appropriately.

The last couple of blogs have covered valuations and how we find them.  Every time a company raising new capital it is setting a new valuation, selling a portion of the equity, and is re-establishing an exit target.  There are reasons to raise new money, and there are costs and risks associated with each incremental raise that I will try to outline here.  I’ll walk through the funding process from the perspective of new company – HotStartup.  Without further ado, I present – A New Hope.

Friends and Family

When HotStartup is first starting out, it is just an idea in the back of our heads that will solve the Middle East conflict, eliminate starvation, and fix the healthcare system all in one shot.  It’s a rocket ship and we know it will work.  To get the first few dollars to build a prototype, get some first beta versions coded up and tested out we will use our own money, ask friends, family and anyone we know for some help.  This is called a Friends and Family round, and really represents people putting money into the business based their relationship with you, and less about the actual business.  Often this is in the form of a loan, credit cards, mortgage on a house, etc.  Not really selling any equity, or if you are, it is part of the founder’s share of the business.

Angels / Seed Stage

But, since HotStartup is the best thing since, well ever, we see some great traction from our test customers and are starting to really refine the product.  To get the whole thing working, we will try and raise $1,500,000 of capital in order to hire a few people and really build an enterprise ready product.  At this stage, we are trying to raise an Seed Round, where either an institutional Angel group or seed stage investor will invest (such as Hub Angels or NextView Ventures) or even some privately wealthy individuals throughout our geography (such as high profile MA angles like Jonathan Kraft).

At this point, we need to start thinking about valuation and how much equity we are willing to part with.  Since we don’t have sales or revenue to benchmark against, it is hard to know how much the business is worth.  Often people will look at industry averages for a seed stage business, which the median pre-money valuation is currently is ~$5.2mm (mm = million, each “m” represents 1,000x, so $4m =$ 4,000, $4mm = $4,000,000).  Since we have already covered pre-money valuations, we understand that our pre-money valuation of $5.2mm and a total equity raise of $1.5mm yields a post-money valuation of $6.7mm, and we are selling 22% ($1.5mm/$6.7mm = 22%).

Series A

We’ve got it!  A full product, we’ve tested it out and people want to buy our HotStartup software.  AWESOME!!  This is fun.  But, do we want to sell this as a perpetual license (think Microsoft Office, you sell a CD with everything on there, and people can use it for the rest of time), maybe a subscription license (where people pay us monthly/annually, like Netflix), or even a fully hosted SaaS solution (the newest trend is a SaaS offering, meaning we not only sell the product as a subscription, but also host it on our own servers).  This process of figuring out the business model is when we go and raise a Series A round, with some really good venture capitalists that will help us think through things and guide us.

Again, it is a little early to really set the valuation based on our sales, but we aren’t just an idea anymore.  Maybe we set things based some other user metrics or try to get a valuation of the business from a potential acquirer.  For HotStartup, we will assume an industry average increase in the valuation of the business – a new pre-money valuation of $9.2mm and we can raise an additional $4mm cash (again, pre-money of $9.2mm plus the $4mm of equity raised yields a $13.2mm post-money, selling a 30% stake in the business)!  This represents more dilution for us as founders, but also dilution from Angel investors.

Making it rain

Since we have some ideas of when, why and from whom we can raise money, let’s focus on some of the nuances of what this all means and how it impacts us.  I’ve attached a breakdown of how the cap table would look if we raised new money from one investor at a time, with no participation from past investors.  This is a simplification of the fundraising process, but helps to show how our founding stake in the business quickly goes from 100% to 54% after the Series A.  After the Series A round, the implied value of our shares has been rising quite rapidly and is worth $7mm!  So dilution means we get a smaller percentage of the company, but it is at a higher valuation.

In Part 2 we will cover financing through the end of venture (usually considered Series D), while finishing up in Part 3 with an analysis of some of terms in a venture contract (liquidation preferences, participation rights, drag along rights, anti-dilution clauses, etc.).

Seed and Series A Cap Table

It’s worth what?!

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The fundamental question, how much is that puppy in the window?  We’ve covered how to understand what pre and post-money valuations are.  So the next valuation question, why is the pre/post-money valuation so high/low?  There are as many ways to value a business as there are stars in sky, and not all have much rhyme or reason (e.g. why is Snapchat worth $3 billion? I have no idea…).

Let’s start this discussion with the basic valuation technique, known as the discounted cash flow model.  In order to value a business, we look at the future cash flows from a business and apply a discount to those future cash flows, until we end with one number (called the net present value).  We can get very technical very quick with some nice models, since most stocks are valued this way.  But, venture businesses are not so I’ll save the models for later.

Venture businesses are not valued based on the discounted cash flow model because there are no future cash flows for a LONG time.  A great success story for the venture community is Workday, which was founded in 2005 and generated positive cash flow for the first time last year.  Pretty hard to value those cash flows almost nine years later.  Venture businesses are usually valued on different sets of metrics, the most common of which is a multiple of revenue.

That math is easy.  Let’s look at RingCentral (publicly traded – ticker RNG, but a still traded based on a multiple of revenue like a venture business).  They generated $148.3 million of revenue over the past twelve months (a common term used for the last twelve months is the “trailing twelve months” or TTM), and have an enterprise value of $1.17 billion (enterprise value is a term to define the total worth of a company).  This represents a multiple of 7.9x ($1.17B / $148.3M).  Pretty simple right?

But how do venture funds decide what multiple of revenue to use?  That is key question to almost every venture deal.  Usually a VC will create a “comp set” (competitive set), consisting of businesses that are similar based on a few key aspects.  Usually the business model is the first on the list.

A business model is the way in which a company generates revenue.  An example: Netflix charges a monthly fee to its customers; this business model is called a subscription business model.  But no one would think that Netflix and Workday belong in the same comp set – yet they do have the same subscription business model.  That is why there is consideration given to the industry a business operates in, the type of customer, the geographic diversity, the technology platform, the growth rates, the gross margins, end user adoption, customer engagement rates, etc.  There is no perfect mix, and it’s more of an art than a science.

You can also use a multiple of something other than revenue.  Companies like Snapchat that don’t make any money still are valued based on a multiple.  In Snapchat’s case, they are valued based on a multiple of their users.  Foursquare, Twitter and Facebook were at one point all valued based on their users.  Revenue multiples are just one of many options to set a valuation, but it is the most common.

Putting this valuation technique to work, let’s go back to our Company XYZ.  Company XYZ wants to raise money, and needs to set their pre-money valuation.  If I were the CFO (conveniently in this example, I am!), I would start by creating a list of public and private companies that are similar to mine, and find a couple of multiples to value those businesses.  If Company XYZ were a cloud company, I could use the Bessemer Venture Partner’s Cloud Comps median enterprise value (EV) to revenue multiple of 9.9x to set my valuation based on my 2013 revenue.  If we generated $15 million in 2013 and grew at a strong rate, I would look to raise money with a pre-money valuation of $148.5 million (9.9 * 15M = 148.5M).

There it is.  That puppy in the window costs $148.5M.  Valuing a business that is losing money at very high rates is not easy, and tests the basic thesis of the discounted cash flow model.  But when we find a common set of metrics to base that valuation on, you will see that it isn’t that extreme.

Just for reference, check out the EV/Rev multiples (enterprise value to revenue multiplies) of a bunch of well-known companies below:

Comp set

Valuing an investment

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We’re getting it.  Big institutional investors give money to venture funds, which in turn invest that money into companies.  Those companies grow like crazy, get sold for lots of money and everyone is happy.  If only things ever were that simple.

In order to understand what type of investment works best for a start-up, it important to understand how these companies are valued, how investments ultimately are structured, and how each party (institutional investors, venture funds, and the company) share in the ultimate profits.  Each investment type is a little different, and there are lots of ways to structure a deal.  We’re getting a little ahead of our ski tips here, so let’s understand how to calculate the value of company when they raise money.

Most investments we hear about are equity investments.  It’s what venture capitalists (VCs) do, and it is how most companies are able to raise money.  In the most basic sense, venture capitalists are doing the same thing you do on E-Trade when you buy stock in Google.  Your stock is actually ownership in Google, and ultimately entitles you to the profits of the business.  Venture capitalists are just buying much larger amounts of ownership in much younger, smaller companies.

Using an example is probably the easiest way to think about this.  I love Dropbox, and many of you likely do too.  Well, they just raised $250 million at a $10 billion valuation.  So, how much equity did BlackRock (in this case, the VC that made the investment) get in the business?  The simple way to calculate the amount of equity is divide take the amount of money invested ($250 million) by the valuation of the business ($10 billion).  So in this case, 2.5%.

Wait, what? Why does this matter?

Think of it this way, if we are giving a company $250 million, we just made that company worth $250 million more.  So when we invest our money in a business, we are actually making it more valuable!  So we calculate what is known as the pre-money valuation, and use that to value our investment.  In a normal, simple deal, the pre-money valuation is simply the valuation we hear about (known as the post-money valuation), and subtract the amount of capital raised.

In the Dropbox example, this means we take the $10 billion post money valuation, subtract the new capital raised of $250 million, and get a pre-money valuation of $9.75 billion.  Although that is not a big change in this example, it is a big difference in the smaller deals.  A $20 million investment in a $100 million business would be 20% (if that $100 million investment represents the post-money valuation). From a Company’s perspective, they went out to raise money at an $80 million pre-money valuation.

This is boring.  You’re bored, I can tell.  Honestly, I’m bored too.  But, it matters.  It matters a lot actually.  Remember last time we talked about A16Z investing $22 million into Silver Tail and selling it for $2.1 billion dollars?  Well, without knowing the valuation that A16Z invested into Silver Tail we don’t how much money A16Z made.  If A16Z invested their $22 million into the Company at a $3 billion valuation, they actually would have LOST money, despite it selling for $2.1 billion!

We hear of the big numbers a lot.  But they really are only part of the story, and we rarely hear the whole story.  Taking it all the back to our E*trade account: you bought stock in Google Thursday (1/16) and sold it on Friday (1/17) for $1,150 – that’s a lot of money!  But it doesn’t mean anything… you would have paid $1,156 for it on Thursday.  So selling it on Friday, you actually would have lost $6.  That’s why the valuation is so important.

That is why we care and why it is important to understand the whole picture.  Pre-money and post-money valuations are not interchangeable, and make a huge impact on the actual returns to the venture fund and to the company.  They change how much equity a company has to give away to get new money, and at what price an investor is willing to invest in a company.

Back to Basics

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Let’s start with how venture funds are set up, and where the money for venture investing comes from.  Venture investors usually raise money in the form of funds, often referred to as LP/GP funds (LP = Limited Partners, GP = General Partners).  Venture funds can range from $25 million up to more than $1 billion, and really there is no limit.

These venture funds raise their money from institutional investors.  Institutional investors are VERY large investors with lots of money (typically an institutional investor will have $250 million to $100 billion plus), think college endowments, public pensions, corporate funds, insurance companies, and high net worth individuals.  These intuitions are known as the LPs (limited partners) in the funds, because they invest their money, but make no direct decisions related to the actual investments.

The venture funds have a team of professionals, known as the GPs (general partners).  These professionals are the ones that will decide how to invest the millions of dollars raised, but not without some rules.

First, the venture funds don’t actually get all the money upfront, but the institutional investors hold on the money until a couple of days before the venture funds need it.  Each time a venture fund needs money, they issue a “capital call” to the institutional investors.  The venture fund is only allowed to issue capital calls for three to five years from the time they start investing money, which means the full amount of the fund (between $25 million and more than $1 billion, remember?) has to be completely invested in the first couple of years!

After three to five years, the next three to five years are known as the “harvest period”.  During this time the venture funds investments are hopefully growing from small companies to really big companies.  But there is no more money going in or out of the fund (kind of, there are other things happening, but for simplicity we will stick with this story).

At the end of the “harvest period”, the venture funds start the “liquidation” of the portfolio.  This results in the venture fund selling all of their businesses; through taking a company public or having another company buy their company (e.g. Google buying Nest Labs for $3.2 billion).   As they sell their business, they are hopefully making lots of money for the institutional investors and returning all of the money.  This whole process, from closing a fund through full liquidation takes 10 years to 12 years (the funds are structured where they are not ALLOWED to last longer than that often).

So, in about 500 words, there it is.  The entire system of venture funds and institutional investors made simple.  Get it?

I don’t get it…

Let’s try to make things make a little sense of these things through some real examples.  Let’s start with who invests in the venture funds and go from there.

Here’s a perfect example: Andreessen Horowitz (known as A16Z) is raising a new venture fund, on the larger size, of $1.5 billion.  Since this isn’t their first fund that means that they already have a bunch of intuitional investors, which have previously invested in A16Z’s funds.  Those investors (many of which are publicly known through a filing with the SEC called a Reg-D) include the Stanford University Endowment (an endowment, obviously), Bloomberg (a public company), and Accolade Partners (a fund-of-funds investor, think a really big private mutual fund).  Each institutional investor will pledge a portion of the full $1.5 billion A16Z is looking to raise.  Simple example, if Stanford commits $150 million (10% of the full fund), every time A16Z needs money, Stanford’s capital call will equal 10% of the total money being requested.

Once A16Z closes their fund, they will start to make investments in new companies.  Using an example from last month, A16Z invested $20 million in Teespring.  In order for A16Z to actually get the $20 million needed to invest in Teespring, they needed to issue a capital call to the institutional investors (such as Stanford, Bloomberg, etc.).  Those institutional investors sent money to A16Z in order for A16Z to invest in Teespring.  In our past example, Stanford would be responsible for sending $2 million to the Teespring investment (10% of the $20 million capital call).  For the next three to five years, A16Z will support Teespring and help Teespring grow, hopefully selling the business for lots of money.

Speaking of lots of money, A16Z is pretty good at making it.  Like back in October 2012, when they sold a company called Silver Tail Systems for $2.1 billion, after investing an estimated $22 million in June 2011.  When this happened, A16Z has to distribute that cash back to their institutional investors.  Because they invested about $20 million, and sold it for $2.1 billion, those investors are very happy.  Now A16Z didn’t necessarily make 10x their money (I’ll explain that later), but they definitely made a lot.  In our example, Stanford would receive their 10% of the total distributions!  Because those investors are very happy, they will invest in A16Z’s new fund today.

So, with a few examples, this is hopefully a little clearer as to who gives whom money, and why.  These basics apply really to all private equity and venture capital funds, and like anything in life, there are exceptions and special cases; but the vast majority of funds are set up this way.  We’ll get into some more interesting specifics soon, but I felt we needed baseline to start from.