Cheatsheet for Crypto Founders about VC Game

Increase your chances of successful fundraising and deprive yourself from illusions

Fundraising is a game. And as in any game, if you want to win, you need to know the rules and your opponent's weaknesses, strengths and desires.

What Is A Venture Capital Fund?

1. Venture capital funds are pooled investment funds that manage the money of investors who seek private equity stakes in startups and small- to medium-sized enterprises with strong growth potential.

2. Thus, every VC fund has fund managers called general partners (GPs) and investors they raise money from called limited partners (LPs).

How Do VCs Make Money?

1. Management Fee

   1. Management fees are an amount, typically calculated as a percentage of the funds committed to the firm, that limited partners owe annually to the venture fund in which they are invested. Typically, it’s 2-2.5% annually.

2. Carry

   1. Carried interest (carry) is a performance fee, in the form of a portion of future profits from an investment, paid to general partners or fund managers in a venture capital firm. Carry is calculated as a percentage—typically between 20% and 30%*—of the return on investment after limited partners have been paid out 1X their investment.

3. Example

   1. if GPs raise $100M VC fund, GPs have $2M per year (let’s assume a constant 2% fee over the years).

   2. In 10 years, GPs exit all their positions and accumulate $300M.

   3. They return $100M to LPs(1X their investment), then $200M is the profit out of which GPs take 20% - $40M. The rest ($160M) is paid back to LPs.

As you can see, the venture capital game is all about maximizing upside potential, as GPs earn a significant portion of their compensation through performance-based carry.

How Do VCs Earn Carry?

To create an exit opportunity for VCs that adds up to the carry value consideration, startups need to grow significantly. This high growth eventually leads to three common exit strategies:

1. Public: IPO - An initial public offering (IPO) refers to the process of offering shares of a private corporation to the public in a new stock issuance. Simply put, it's when individuals can buy stock freely on the open market, such as shares of Google or Nvidia. For investors, this means they have the opportunity to sell their shares to the public.

2. Private:

   1. Later-Stage Exit. Startups progress through various stages of maturity, from the pre-seed stage (idea stage) to Series A, B, C, and beyond. If VCs invest early (pre-seed/seed) in a project, they might sell portions of their shares to growth-stage investors as the company matures.

   2. Mergers and acquisitions (M&A) refers to the consolidation of companies or their major assets through financial transactions between companies. Essentially, it’s when one company buys another. For example, our exit from DMarket was through its acquisition by Mythical Game

3. Fundamental

   1. Dividends. At some point, startups may become profitable (generating more revenue than expenses). When this happens, they might redistribute a portion of their net profit to shareholders. However, this is the least favored scenario for investors, as it doesn't provide the extreme returns that other exit strategies might offer.

What Increases Carry Potential?

The potential for increased carry is driven by several key fundamentals, such as revenue and user growth. Achieving these outcomes requires aligning numerous components, including:

1. Execution of the Team

   1. Experience

   2. Tech/non-tech split

   3. Motivation

   4. Ability to capture a market share, etc

2. Product Innovation

   1. Disruptive nature of the product

   2. Unlocking fundamentally new capabilities

3. Market Size and Dynamic

   1. Market potential in billions of dollars—the larger, the better

   2. Rapid growth and potential for a paradigm shift

4. Timing

   1. Why now is the perfect moment?

For an entertaining discussion on fundamentals, check out the famous episode from "Silicon Valley" below. For those who haven't watched the series, it's an absolute must-see

Is It Easy To Earn Carry?

VCs make a lot of money, and with so many exit opportunities, it might sound easy. Are you excited to launch your own VC fund? Let me give you some extra points to consider.

1. Public: IPO

   1. It typically takes about 12 years for a tech startup to reach an IPO. Given that the average VC fund term is 8-10 years, GPs often can't exit before the fund term ends. Additionally, the current market dynamics is not favorable for timely exits.

2. Private: M&A/Reaching Next Stage

   1. According to CB Insights, 99% of VC investments fail. The typical venture investment landscape is stark: out of 1,098 investments, only 5 companies (less than 1%) become unicorns.

This means venture capital is a game of heavy outliers. If GPs are unable to find one startup that provides extreme returns (100x+) or a few that offer super returns (30x+), they will not achieve carry. Without carry, LPs will be dissatisfied with the fund's performance and are unlikely to provide funding for future funds.

How is Performance Measured?

Performance in venture capital is typically measured using several metrics. One key metric is DPI (Distributions to Paid-In), which assesses the cumulative value of distributions paid to investors relative to the capital invested (cash-on-cash return). The benchmark for comparison is often the S&P 500 index. If the DPI multiple exceeds the growth of the S&P 500 over the same time horizon, it is considered a strong performance result.

Are Crypto VCs Different?

Fundamentally, crypto venture capitalists also aim to achieve carry. However, the presence of tokens, industry cyclicality, and the evolving market structure differentiate the crypto VC game.

1. Tokens’ TGE represents an evolution from traditional IPOs

   1. Time to liquidity has drastically shortened. Nowadays, projects can launch a token and become publicly tradable with just a few clicks. This eliminates the need for crypto VCs to wait 12 years for an "IPO" moment to exit.

2. Industry cyclicality, such as the DeFi summer, NFT boom, and Play-to-Earn (P2E) trends, influences investment dynamics

   1. Short-term spikes of attention and constant narrative shifts characterize this volatile market, often driven by one category outperforming others. This makes it challenging to maintain long-term belief in any single category, as it could fall out of favor in the next quarter. Moreover, the short-term nature of these trends complicates capitalizing on investments, especially since tokens may be locked up until a project reaches a liquidity event, potentially causing investments to lose value during that time.

3. The majority of crypto VCs invest in the seed stage. There is a notable lack of Series A and later-stage funds in the crypto ecosystem

What Incentives Does This Structure Create?

1. For founders, there's an incentive to manage multiple projects simultaneously. Only a few founders can scale projects to later stages. Even for those who do, there's often insufficient capital available to support them. For many, a simpler and potentially more optimal approach is to run multiple projects concurrently, directly or indirectly. If funding is secured for any of them, preparations for a token launch can begin, allowing for a gradual exit while contemplating or working on the next "VC"-worthy startup based on the narrative.

2. For large VCs with substantial dry powder (funds exceeding $200 million) and a strong brand, there's an incentive to inflate valuations and subsequently sell their positions over-the-counter (OTC) to other VCs unable to participate in the initial deal. For example, entering a $85 million seed round at a ~$1 billion fully diluted valuation (FDV), assisting the project in achieving a $5 billion FDV upon listing on a Tier 1 exchange, and selling locked positions at $3 billion represents an easy 3x return strategy for these VCs. There is no one buying higher rounds after you and if you calmly wait until your unlocks, you’re taking a huge risks of losing your upside.

3. For smaller VCs, the incentive often lies in a "spray and pray" approach—recycling capital across as many projects as feasible to diversify risk and potentially capitalize on high-return opportunities.

4. I’m hearing more and more that VCs are pushing founders now to launch a token asap. Each VC wants to have some tokens unlocked until the bull market ends, but It fairly pushes the “anti-VC” narrative in crypto.

   

   

How Does SparkGate Approach Fundraising?

1. We understand why we’re building an “Uber for influencer marketing.” It comes down to our team's expertise, the large and growing market, the real problems we’re solving, and clients who are ready to pay for our solution. We don’t just want to be a Tier 1 project in the existing niche; we want to create a new niche and be pioneers in it. This justifies our commitment to focusing on only one crypto project at a time.

2. We’re realists and understand that 100 funds won’t be knocking on our door tomorrow. We’ve chosen the tough path: focusing entirely on the product, which involves active testing and gathering client feedback. We’re not rushing to launch a token within the typical six-month timeframe favored by many crypto VC funds. We don’t expect “Marketing infrastructure” to become the next big narrative, which has significantly reduced our pool of potential crypto VC funds by over 95%.

3. I’ve compiled a short list of funds that are long-term minded, and I’m maintaining relationships with them by consistently sharing product updates both online and offline, as well as new articles like this one. Fundraising is an art and a marathon, especially if you’re not Elon Musk or Sam

4. By understanding the VC game and depriving ourselves of illusions, we’re fine with trying and burning our cash and time for some time, growing step by step. We’re patient believers.

What Could I Recommend To You?

1. Listen to my free webinar about Fundraising

2. Talk to founders about their path, help each other

3. Start Building your momentum

Gratitude

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