Ownership – the outcome of the moment of truth for venture capitalists and founders in their courtship process. If everyone did their parts right, the founders would be happy (ish?) about the piece of the company they are handing over to the VCs, and the VCs would be happy to have a meaningful enough stake in the company they are partnering with.

However – interestingly enough, ownership does not actually matter. Or at least not necessarily per se¹. How can that be when VCs so often have ownership targets and minimums? Let’s take a closer look.

Ownership is defined as the ratio of the number of shares you own over the total number of shares of the company². During a new funding round, the number of shares the investor purchases is defined by the price per share and by the size of the check the investor writes. The price per share is determined by the company’s valuation, which is essentially an assessment of the company’s expected value – that is, a combination of its potential³ and its likelihood of success. The higher the potential and the likelihood of success, the higher the valuation the company can command when asking for funding (e.g., having intellectual property is valuable only inasmuch as it provides the company with a competitive advantage in the market).

When a venture capitalist invests in a company, that investment becomes part of the fund’s portfolio. While every fund designs its strategy, roughly speaking, early-stage funds have more companies per fund than growth-stage funds. There are two ways of looking at this. The first is that as companies progress in their journeys, their likelihood of success increases, and thus, their level of risk is reduced –the venture fund does not need as many companies to ensure a reasonable chance of success for the fund. The second is to notice that as the risk level is reduced, that information has also been incorporated into their valuations, which should now be closer to their (theoretical) maximum potential. Hence, higher valuations mean lower levels of risk and less upside. Because power law dynamics drive venture capital, the investor must ensure each investment is large enough and has sufficiently high upside to drive outcomes at the portfolio level or risk investing in the right companies and still having a poorly performing fund⁴.

Let us now tie all of this back together. Because ownership summarizes several critical things about the investment, such as the amount, valuation, and the company’s potential multiple of invested capital, a minimum level of ownership acts as a shorthand for the discussion above: a large enough check for the fund’s portfolio math to work. This doesn’t mean that the number is meaningless, however: in many cases, ownership targets are agreed upon and tracked by the fund’s LPs, so whatever the rationale, it has also become a formal performance metric for venture capitalists.

Additionally, there are a few additional reasons behind ownership minimums, some more important than others. For example, certain ownership levels may come with special rights, such as pro-rata investment rights in future rounds or comprehensive information rights, as well as with increased governance controls, such as special protections for the investor, board observer positions, or board seats. However, many of these benefits depend more on negotiation than specific ownership levels (more significant stakes do translate to stronger negotiating positions).

Ultimately, however, the success of the partnership between a VC and a company depends not on arbitrary ownership levels but on their alignment regarding the company’s potential and the value created by the investor beyond that of their financial capital. So, as they say, “your mileage may vary.”

Some Good Reads

What was I made for: Large Language Models in the Real World | J.P. Morgan Asset Management (jpmorgan.com)

This month’s Eye on the Market returns with an assessment of ChatGPT performance that felt particularly relevant for knowledge workers who are not computer scientists or coders. It does some things very well, but when it comes to data, you should remember: if you have to check everything, how much more productive are you actually getting? It also highlights MIT research that shows the impact of automation seems to have become net-negative for workers sometime in the 80s (having been positive beforehand). Something to think about regarding the potential impact of AI.

The hidden digital roadblock that’s keeping green electricity off the U.S. grid | Science | AAAS

A successful energy transition will require a larger electrical grid. Commonly discussed improvements, such as virtual power plants (VPPs) can help alleviate some of the grid needs. For context: a VPP is more or less a collection of energy resources, like batteries, that can be managed together via software to act as a single asset; the aggregate scale means small assets that are too small to matter can suddenly become a relevant part of grid management activities. However, something that I rarely see discussed is how managing the grid also requires extensive simulation work to understand how the assets on the grid (and potential additions) will impact the ability of the physical cables to move electricity around. It turns out (!) there may be significant capacity to be unlocked via improved simulations & assumptions. Also this one comes with a free meme: nvo on X: “sorry”

How would room-temperature superconductors change science? (nature.com)

We recently went through a superconductor frenzy (particularly in social media) when the material known as LK-99 made the news as the first-ever identified potential room-temperature superconductor. Unfortunately, it turned out not to be the case. But – why all the drama about that? Read this one to find out more. Interestingly enough, because their properties usually keep getting better the colder you go, even if we find a room-temperature superconductor, we may need or want to cool it down a bit anyway!

Coverage on the 2023 Nobel Prizes.

General coverage from The Economist: The 2023 Nobel prizes honour work that touched millions of lives (economist.com)

Chemistry Nobel on quantum dots. These are nano-scale particles that have unique optical and electronic properties (vs. their larger counterparts). In fact, some of their properties resemble so closely those of an atom that they are sometimes called ‘artificial atoms.’ These magic-sounding things may be in your TV: Tiny ‘quantum dot’ particles win chemistry Nobel (nature.com)

Physics Nobel on ultra-short laser pulses. If you’ve ever wondered how we can image electrons and their atomic and molecular shenanigans, this is it: Physicists who built ultrafast ‘attosecond’ lasers win Nobel Prize (nature.com)

Is it possible to create magnetic semiconductors that function at room temperature? | Science

Spintronics is a fascinating emerging discipline. Not a pure research article, but intense & rewarding to read. The future of many devices could be through this avenue.

The Truth about College Costs | National Affairs

If you are American, you may already know all of this. However, I found it fascinating. The market gets distorted on its surface as money charged by colleges starts to become a proxy for quality, so we end up in a situation where every college is incentivized to charge more or less the same. However, since only elite colleges can actually charge that sticker price, a web of scholarships/discounts develops in every other college to maintain the original price-differentiated structure.

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Footnotes

¹ Whereas private equity investors regularly obtain majority ownership when investing, venture capitalists rarely do. Over time, the cumulative ownership of all VCs will surpass 50%. Still, even then, the overall ownership of the company will be quite fragmented, and a single fund will not drive company governance. Go back.

² For simplicity’s purpose, I will skip the discussion around currently outstanding shares, fully diluted shares, and so on. Assume everything refers to fully diluted shares. Go back.

³ VC-backed companies must undergo a transition at some point from being valued on their potential (i.e., future revenues, margins, and further growth potential) to being valued on their realities and track record (i.e., actual revenue, margins, and believability of their future projections). For this discussion, we’ll stay firmly planted in the ‘potential’ framework since that is the one that applies to most VC funding rounds. Go back.

⁴ This is a fancy statistical way of saying that most of the returns of any venture capital fund come from a small number of companies in the portfolio. The implication is that the investment amount and the potential multiple on invested capital for each investment must be large enough to single-handedly drive the returns of the entire fund. Go back.