Dec 12, 2012 VC
Part 3 A Vc Firm Makes Money Accel And Facebook Case

In this third post, I’m going to explain why venture capital firms invest in stages and not in a one-time-big-investment and why Facebook is receiving rounds of investments.

Venture capitalists want to have some control in their investments. By staggering their investments in rounds, they can evaluate if the startup should receive more money or not. In this way, the VCs can monitor the entrepreneur’s progress and gather additional information to make a sound investment.

From the book “The Venture Capital Cycle – 2nd edition” on page 173, we have the Apple Computer’s story that illustrates this well:

“Apple Computer received three rounds of venture capital financing. In the first round, venture capitalists invested $518,000 in January 1978 at a price of $0.09 per share. The company was doing well by the second round of venture financing in September 1978. Venture investors committed an additional $704,000 at a price of %0.28 per share, reflecting the progress the firm had made. A final venture capital infusion of $2.331 million was made in December 1980 at $0.97 per share. At each stage the increasing price per share and the growing investment reflected resolution of uncertainty concerning Apple’s prospects.”

Besides, these rounds of investments may have some names such as Series A round or B or C or even D rounds.

From the entrepreneur’s side, these round of investments may mean that they achieved a milestone event such as breakeven, getting their 1,000,000 customer, having the patent granted, having the drug trial phase IV passed, etc.

Back to the Facebook and Accel example:

Facebook received its first investment of US$500,000 in June 2004 from PayPal co-founder Peter Thiel.²⁵ This was followed a year later by $12.7 million in venture capital from Accel Partners, and then $27.5 million more from Greylock Partners.²⁵²⁶ A leaked cash flow statement showed that during the 2005 fiscal year, Facebook had a net loss of $3.63 million.

So, in this little paragraph, we see that Facebook had at least 3 rounds of investments until 2005.

- Peter Thiel: US$ 500,000
- Accel Partners: US$ 12.7 million (Accel invested probably because Facebook achieved some milestone)
- Greylock $27.5 million (Greylockinvested probably because Facebook achieved some milestone, but probably it had to pay more for less share)

Much later, we had the Microsoft’s investment of $240 million.

Let’s pick up Accel’s investment and see how its investment increased in value.

Among venture capitalists it’s a poorly kept secret that Facebook’s valuation came in just shy of $100 million. Assuming that’s true (Mr. Breyer declined to say), Accel paid a little more than $12 million for roughly a 15 percent share.

So, in later reports, Accel still has 11% of the company. This means at the time of Microsoft’s investment, Accel’s investment was valued from US$ 12.7 million to US$ 1.65 billion. That’s an increase of 130 times of their initial investment!

Other VCs and investors invest in Facebook because they hope that their shares will have a similar increase value of their investments.

You wonder if this is the way VC makes money. This is simply the value of their investment; however, they need to “transform” their shares of the company into money.

This transformation is what VCs call “exiting event”.

The “exiting event” can be divided into four types:

- Staying private

- IPO

- Bankrupt

- Acquired / Merger

In the part 4 of this post, I will show what would happen to Accel’s investment for each of the exits. Then, we conclude how VC firms make money.

The news that you saw from the image were taken from these pages:

Twitter Raises $35 Million Series C From Benchmark and IVP

MARINUS PHARMACEUTICALS RAISES $20 MILLION IN SERIES B FINANCING

Wozniak’s storage startup Fusion-io raises $47.5M more

Irvine Chip Startup WiSpry Nabs $10M Funding

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