Fun with VC Math: Designing Funds & Exits in Africa
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Welcome to Track 8 of The Trajectory Africa, a podcast series exploring the trajectory, or pathway, of venture capital and startup formation in Africa. This episode’s guest artist is Eghosa Omoigui. Eghosa is the founder and Managing General Partner of EchoVC Partners, a seed and early-stage technology venture capital firm investing in underrepresented founders and underserved emerging markets. Prior to Echo, Eghosa worked for Intel, and in his last role served as the Director of Consumer Internet & Semantic Technologies for Intel Capital. A Kauffman Fellowship mentor, Eghosa is also engaged with organizations that support women founders and angel investors such as Astia, where he’s on the Venture Advisory Board, and Rising Tide Africa, where he’s a Board member. He attended law school at the University of Nigeria and University of Pennsylvania and business school at Babson College.

CORRECTION: In the intro to this episode, I erroneously referred to Eghosa as a Kauffman Fellow. He is a mentor for theKauffman Fellowship. Also, EchoVC is always EchoVC, not Echo.

NOTE: If you're struggling with the mental math featured in this episode, please see the FAQ with Eghosa at the bottom of the show notes. It should help to clarify the underlying logic. 

In this episode, we discuss:

  • Why EchoVC aspires to be the Sequoia Capital of emerging markets
  • Why consumer market opportunities are tough to crack
  • What it *actually* takes to return a $50M fund (Spoiler alert: It’s harder than you think.)
  • Why valuation and ownership impact fund outcomes so significantly
  • Why investing in women (among other things) is a key element of portfolio construction
  • A mini case study on hypothetical fintech company Moolah Mountain to explore how investing decisions impact fund economics

Eghosa’s Recommended Track & Featured Resources:

DJ Saphir’s Spotify Playlist:

FAQ with Eghosa:

  1. Why does it take $500M to 1X a $50M fund and $1.35-1.4B to 3x a $50M fund? 

Portfolio construction is the short answer. If you assume you own 10% of a startup at exit, then $500m of enterprise value created returns $50m. So it's not solely a scenario where a company in the portfolio exits at $500m, but what percentage you own at the exit. By the time you assume dilution, it gets harder to own 10% at exit.

2.  Why does it take 10 Paystacks to return a $50M fund?

With Paystack, assume the exit multiple was 14.4x and assume you invested $1m into it. That is a $14.4m return sans dilution. You'd need to do that 10 times to return ~3x the fund. 

This is not impossible but the assumptions about the entry price and the dilution that occur during the path to exit mean that the Paystack example is unusual. It raised just a Seed and a Series A prior to its $200m exit so the dilution was not material. Many companies may raise 3 or 4 times and that is where your starting ownership goes to die. I have seen quite a few Series Es and Fs. Series Gs and Hs exist.

3. How do the outcomes change when you introduce failure rates?

A ten-year $50m Africa fund with a 2.5% fee and expenses may leave you ~$38m to actually invest but let's use $35m of investable capital to illustrate.  Let's say your strategy is to invest $1m checks, and assume you reserve $10m to defend your pro rata in certain deals. FWIW, a 20% reserve ratio is on the low side and it's more common to see 30-50% of the fund set aside for reserves.

You make 25 investments (25 * $1m = $25m), and your avg postmoney entry valuation  is $10m so you buy 10%. Then you apply your reserves to defend your pro rata at the A (which are usually $15m+ rounds) so your check size is say, $1.5m. That means you can do ~6 follow-ons to protect your initial 10% holding.

If all 6 exit after that point so they don't raise again (almost statistically impossible), then you hold 10% of the aggregate exit value. You would have invested $2.5m ($1m initial check plus a $1.5m follow on) into each of the 6. Assuming they are all Paystack type exits at $200m (sure, everyone thinks they will be unicorns but actual exit data belies that) then your gross return from the 6 companies is $120m (10% * $200m per company * 6 companies). 

But remember we started off by investing in 25 companies. 

If 50% fail to return 1x or better, (remember that batting .300 (3 in 10) in major league baseball likely gets you in the hall of fame) then we are looking at ~13 companies to drive the fund returns. Of these 13, 6 based on our example will return $120m. Maybe the remaining 7, representing $7m of investments return 3x (unlikely but let's say so just for shits and giggles). Then the aggregate fund return is $120m + $21m = $141m.

On first read, that's a smashing success for a $50m fund and delivers the 20% carry (profit share) to the manager.

Here are some quick calculations to illustrate the return multiples.

$141m: dollars returned.

$35m: dollars invested by the GP.

$50m: dollars invested by LPs.

$141m/$35m = 4.02x $-at-work gross; 

$141m/$50m = 2.82x trued up gross;

$141m - $50m [$91m] * 80% [$72.8m] + $50m [$122.8m] ÷ $50m = 2.45x net to LPs. 

This example of course assumes no recycling i.e. the GP taking interim returns from early exits and reinvesting so that (s)he can get to invest the full $50m and not the $35m after fees. Doing so improves the odds for the fund as more dollars are working via startups and not just underwriting fees and expenses.

2.45x is still a great VC fund net return (that should put you in the top decile globally) but don't get too excited as Thoma Bravo and Vista Equity (multi-$B PE funds) have exceeded this threshold.

But to have six Paystack exits (and seven 3xrs) is quite the dream. I'd sleep in for that.

This then leads us to the power law. That is, one company sets up to return the whole fund. But for that to happen in a $50m fund, you have to have at least one $1b exit and own 5% of the company at exit (and after dilution). With the fundraising froth and (increased) round sizes, many companies would have raised 4-5 times before they become unicorns. That's at least 3-4 dilutive rounds.

This brings us full circle to why the entry price always matters. Buying 10% for $1m makes it harder to own 5% at a billion dollar exit. Buy 20% and then you have a shot. 

But the entry prices are now so high (e.g. valuations for pre-seeds in the high single digits and seeds in the high teens or more) and the competition to invest is so excitably frothy (with price-insensitive investors committing hundreds of thousands of dollars after the first meeting), that $50m funds may actually need up to three unicorn exits to have a shot at returning 1x.

This business is like many others. It may seem easy from the outside looking in but it's really much harder than it appears and takes a long while to be successful. I am grateful to have found a career that I love and would do for free but make no mistake, it requires a ton of hard work, conviction, adaptability, and luck.

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