How VCs decide what size check to write

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When a founder receives a larger investment from one VC fund over another, it’s easy to assume that one of those VC funds has higher conviction in the deal than the other.

Sometimes that is true. But oftentimes, the difference has less to do with how much each investor believes in the company and more to do with the construction of the funds they are investing from.

Let me explain.

Every venture fund is built around a set of constraints:

A check is not an isolated decision. It is one piece of a much larger portfolio.

Understanding that portfolio construction can help founders interpret investor behavior, and help aspiring VCs understand why identifying a great company is only the beginning of the investment decision.

Imagine a venture firm raises a $50 million fund.

The firm cannot invest the entire $50 million into companies. Some of that capital will pay for management fees and fund expenses over the life of the fund. The remainder becomes investable capital.

The firm then needs to decide how to divide that capital between initial investments and follow-on investments in its existing portfolio.

For simplicity, assume the firm plans to deploy approximately half of its investable capital into initial checks and reserve the other half for follow-ons.

If it intends to make 25 initial investments, the average first check might be around $1 million.

That does not mean every company receives exactly $1 million. Some investments may be smaller and others larger, but the average matters because portfolio construction ultimately has contraints. Writing a $2 million check into one company may mean writing smaller checks elsewhere, investing in fewer companies, or using capital originally intended for follow-ons.

This is the first thing founders often miss: a venture firm cannot decide how much to invest based solely on how much it likes the company.

Every check affects the rest of the portfolio (!).

Most venture firms do not begin with the question, "How many dollars should we invest?"

They begin with some version of: "How much of this company do we need to own?"

A fund may target 10% ownership at entry. Another might target 5%. A smaller fund participating in rounds rather than leading them may be ok with 1% to 3%.

Ultimately, investors usually optimize for ownership % in a round and then back into check size.

For example, if a firm wants to own 10% of a company valued at $10 million post-money, it needs to invest $1 million.

If the post-money valuation goes up to $20 million, the same 10% ownership requires a $2 million investment.

This is why valuation affects more than dilution. It can determine whether an investment fits a fund's model at all.

A $2 million check might be too large for a small fund, even if the firm loves the company. A $500,000 allocation might be too small for a larger fund if it results in ownership that cannot become financially meaningful.

Founders often hear that a firm has a particular "check size," but the more revealing question is usually:

What ownership does the firm target?

Venture funds are not only trying to identify companies that will succeed. They are trying to own enough of those companies to return the whole fund and then some back to LPs.

Consider a $50 million fund that invests $1 million for 10% of a company.

If that company eventually exits for $500 million and the firm still owns 6% after dilution, the investment returns $30 million to the fund.

That is an exceptional investment, but it still returns less than the fund's original size.

Now imagine the same firm invested $250,000 and ultimately ended with 1.5% ownership. At the same $500 million exit, the investment returns $7.5 million.

That is a 30x return on the original check, yet it returns only 15% of a $50 million fund.

This is the difference between a great investment and a fund-returning investment.

So here’s the thing: The multiple on the individual check may be extraordinary, but fund managers are judged on the performance of the entire fund.

It is also why larger funds require larger outcomes. A $100 million exit can be transformative for a micro-fund with meaningful ownership. The same exit may barely register inside a multibillion-dollar fund.