The VC Logic Loop

When looking through financials, many VC firms want to see returns in the range of 10x-30x. For many founders, this can come across as an unreasonable ask. After all, aren’t firms just looking for 3x returns for their funds?

In reality, VCs aren’t being greedy and 10x-30x returns are quite reasonable. To help demonstrate why we’ve put together an infographic and some explanations for each step. You can click here to download a PDF version.

Step 1 is pretty self-explanatory. Every fund has a starting amount. To make the math easier we’ve arbitrarily chosen $100M.

Step 2: Most funds operate off of a 2 and 20 fee model. You can read more about it here. After subtracting all the management fees over a 10-year fund, we can reasonably expect there to be $80M to invest in ventures.

Step 3: Effective VC firms don’t invest all their capital right off the bat. A large amount is reserved for follow-on/double-down investments. In this scenario, we’re initially only deploying $30M across our ventures.

Step 4: According to the Harvard Business School, 90% of VC-backed ventures fail to bring substantive returns. In our fund situation, we have 2/3 of the investments either going out of business or plateauing in value within the first few years. The remaining third now receive the fund’s $50M of undeployed capital.

Step 5: Until this point, we’ve had a total of $60M deployed in companies that had potential. But again another 2/3 are likely to plateau in growth or fail altogether. At this point we’ve reached the aforementioned 90% failure tate. We’re now left with a mere $20M of equity holdings to carry the entire $100M fund.

Step 6: Limited partners in a fund are looking for 12% yearly returns. Most funds operate on a 10-year timeline so this entails 3x compounded returns. To achieve this, the $20M of equity must obtain 15x+ returns.

Note: These numbers are illustrative in nature and oversimplify some elements of the VC process. In the real world, fee structures play out over the duration of the fund, failure rates can vary, and plateaued investments do contribute to returns a small degree.

With that being said, these numbers do hold up when it comes to the average performance of funds. Funds that don’t have at least 7% of their investments hitting 10x+ returns simply don’t hit return targets.

Source: Chris Dixon and Horsley Bridge

Armed with this understanding, you might realize that venture capital isn’t the right fit for scaling your business. Luckily, there are dozens of other options out there. Getting started with us can be a smart step to getting the right funding from the right partners.

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