VCs and fund-of-funds are going to throw tomatoes at me with today's tweet storm:

Ownership *doesn't matter* for early stage investing.

And yet almost every VC and fund-of-fund cares about it.

Here's why >>

1) First some context. Fund-of-funds and VCs are always talking about needing to buy enough ownership in their portfolio companies.

But almost no one questions why.

2) But here's a thought experiment. If you invested $5k into Uber's seed round and held on to the IPO, you would have made ~$25m.

$5k doesn't buy you any ownership. So is that a failed investment? Obviously not.

3) As you can see, this successful outcome is not due to ownership in the company. It's due to *multiples* on the dollars invested.

And this is how every early stage investor should be thinking. Multiples. Not ownership.

4) So how did this ownership-mentality come to being? Ownership is a great mental model for later stage investors.

5) If you have a series B company that is clearly winning and growing quickly, you want to buy as many shares as you can into that co. It is clear that you will get the greatest multiples from ploughing $$ into that co over ploughing money into other cos that are not growing fast

6) As such, the ownership mental model makes sense when you have only a clear *limited # of fast-growth choices*.

But this is not the case at pre-seed / seed. At pre-seed / seed, there are a lot of permutations to get to the same multiples.

7) Here are ways to get to 100x as a pre-seed / seed firm:

a) Get in at low valuations. Get 100x on a decent exit that no one has heard of.
b) Pay up at a higher valuation into a serial founder's co and get 100x on a $10b exit that everyone has heard of.

Everything in between.

8) In the early stage game, there are a lot of paths to get to the same outcome. Let's tie this thought process to pro-rata as well.

Investors are obsessed w/ their pro-rata, which is the amount to re-invested in subsequent rounds to maintain their initial ownership stake.

9) But the right way to think about pro-rata isn't about maintaining ownership. The right way to think about pro-rata is to ask: What is the best way to get the best multiple that I can get on this tranche of $?

10) It may be that doing your pro-rata in a given co is the best way. If you have an incredibly fast growing port co, that could be the best use of that $$.

But in other cases, it could be putting that same $$ into 3 new companies at pre-seed at 1/3 the valuation each.

11) In fact, I talk about this in-depth here: https://elizabethyin.com/2020/10/27/the-myths-of-follow-on-investing-debunked/

12) So quick scenario.

Say you invest $100k into Company X at $5m post-money valuation. To get 100x gross multiple, the co needs to sell for $500m. After 3 rounds of dilution, it would be a ~50x return.

X is raising a new round & asks if you will do your pro-rata.

13) Most ppl would just say "Yes! We need to plunk down $400k to maintain our ownership."

It is possible that's the best use of $400k.

But the right way to think about it is how can I maximize my returns on this $400k?

14) If the co is doing well but not clearly the fastest thing ever, then it might be better to put $100k into 4 more companies at a lower valuation.

Which is the better yielding investment of the $400k? The 1 co? Or the pool of new cos?

15) There isn't a right or wrong answer here, but as a fund manager, capital allocation is about making decisions between choices. I can put $X here or there. Decisions are never in isolation - they are a comparison game.

16) There's a finite amount of capital in a fund & this is why ownership isn't a good mental model for early stage investing.

The best way to allocate capital will vary A LOT from company to company & situations at hand. Blindly maintaining pro-rata isn't a good strategy.

17) Let's also be clear that if you don't do your pro-rata, that shouldn't be a negative signal. Your co could be doing really well and as a result of that, the valuation could be quite high.

18) So there's some weird graph to draw here where you'd do you pro-rata if your co is doing top 1% well. Or also if your co is doing well but is overlooked AND you have insider info.

But if your co is doing well AND everyone knows about it, you wouldn't follow on!

19) Now let's tie this to the present day. I'm seeing a TON of flurry throughout the private and public markets. Companies getting marked up and valued at high numbers. More than I've ever seen in my career.

But, we @HustleFundVC are maintaining discipline when write checks.

20) But it also means I'm seeing a flurry after we write a 1st check.

This year, there have been multiple times where investors have come in days or a wk later & driven up the valuation cap 2-4x!

21) This market is insane!

And so when the co goes out to raise again at the next stage, do we follow on? The follow-on price these days may be 6-15x higher than when we wrote the 1st check.

22) And even if a co is doing well, 100x multiple from the new price isn't necessarily guaranteed - not at seed / A when product-market fit hasn't been established yet.

23) Unless a company has CLEAR product-market fit & is growing outrageously fast - like 50%-100% MoM - at the moment, I tend to lean towards writing 1st checks. In this market.

But, this will change in another few months just like how things were different 6 months ago.

24) But the point of this story is MULTIPLES on your money is what matters. Ownership does not. At early stage.

Going back to first principles is super important since the market always changes and evolves.