What is a good return for a VC fund?
The vast majority of VCs look for a clear path to a minimum 5x or 10x return. This is slightly at odds with the fabled 'fund returner' mantra, as VC fund portfolios will typically contain at least 10–20 companies (meaning 10x-20x is required to return the fund).
Top VCs are typically looking to return 3-5X+ on their entire fund to their LP investors over ~10 years. For this, they need multiple 'fund mover' outcomes in each fund, since many early-stage investments will eventually fail or return only a small % of the fund.
How much in returns do venture capitalists generally expect for their investment in a startup? Actually early stages VC have to expect at least 10x return to average investment in 3-5 years. It is not greediness, it's just a math. If 8 from 10 projects will fail good one should cover that loss for whole fund.
There isn't a one-size-fits-all answer, but generally, an IRR of around 5% to 10% might be considered good for very low-risk investments, an IRR in the range of 10% to 15% is common for moderate-risk investments, and in investments with higher risk, such as early-stage startups, investors might look for an IRR higher ...
Here is a summary of the target IRRs for different types of venture capital investments: Early-stage investments: 30–50% Later-stage investments: 20–35% Industry-specific investments: 30–40% (depending on the risk profile of the industry)
Data from Cambridge Associates shows that investments made by top-quartile VC firms in early-stage companies produced an average internal rate of return (IRR) of over 25% over the last 25 years, performing about 2.5x as well as the public market equivalents over the same time period.
- They have a strong track record of successful investments and exits.
- They have experience in the industry or market where the startup operates.
- They have a good reputation in the startup community and are respected by their peers.
A typical VC firm manages about $207 million in venture capital per year for its investors. On average, a single fund contains $135 million. This capital is usually spread between 30-80 startups, though some funds are entirely invested into a single company, and others are spread between hundreds of startups.
The average multiple for a “home run” VC exit (which drives a portfolio) is 16x. This is driven by the pareto rule in venture investing – because of the high failure rate of startups, the successes need to be home runs to drive portfolio returns. But of course, VCs will actually need more than the 16x at the outset.
The IRR is considered attractive if it exceeds the cost of capital or the investor's required rate of return. A condition that would make the IRR greater than 100% is if the cost of capital was greater than the return on investment.
Is 100% IRR possible?
If you invest 1 dollar and get 2 dollars in return, the IRR will be 100%, which sounds incredible. In reality, your profit isn't big. So, a high IRR doesn't mean a certain investment will make you rich. However, it does make a project more attractive to look into.
A 20% IRR shows that an investment should yield a 20% return, annually, over the time during which you hold it. Typically, higher IRR is better IRR. And because the formula includes NPV, which accounts for cash in and out, the IRR formula is even more accurate than its common counterpart return on investment.
A typical early-stage fund might do 10-15 deals per year, with an average initial check size of $1-2 million, and a target ownership of 10-15%. A typical later-stage fund might do 5-10 deals per year, with an average initial check size of $10-20 million, and a target ownership of 20-25%.
To persuade investors, VC companies often highlight their track record of internal rate of return production. Institutional investors and their advisors use VC firm IRR projections when considering whether to put money into a new fund. They also take into account the historical IRRs of previously invested funds.
US Venture Capital has beaten the S&P 500's IRR by 19% over the last 25 years. Yet returns among VC investors vary wildly, because of the wrong approach. Here's how to build a startup portfolio that gives you consistent and stable returns: 1.
Several articles and research papers have been published on the PME and the comparison of VC versus public stock performance. These studies often show that top-tier Venture Capital funds outperform public markets, while the median or average VC fund may underperform.
Did you know that Venture Capital is one of the best performing investments of the past 25 years? Cambridge Associates reveals that from 2010-2020, the CA US Venture Capital Index generated an average annual return (AAR) of 17.2%, compared to the S&P 500's AAR of 13.9%.
As discussed in the question above, the Internal Rate of Return (IRR), also known as the Annual Rate of Return, for a venture fund should be in the 15% to 27% range. There are approaches that GPs can look at to help improve the IRR results for their LPs.
Adjusting in this way for the selection bias of firms that go bankrupt, the mean return on VC investments is 57 percent per year, still very large but less dramatic that the 700 percent mean before correcting for selection bias.
A typical venture capitalist or angel investor may see hundreds of startup pitch decks every year. They usually spend 2-5 minutes reading each story before deciding whether to meet with the founder.
Can normal people invest in VC?
Not everyone can invest in a VC fund – only accredited investors can. These individuals and institutions are deemed eligible to invest in certain investment opportunities restricted to the general public.
Take the difference between the current value of the investment and the original beginning value, divide it by the original value and multiply the result by 100. If a VC fund makes multiple investments at different times, the calculation gets more challenging, but it still can be done with some basic math.
Moderate estimates: 30-40%: The National Venture Capital Association estimates that 25-30% of VC-backed startups completely fail, mean.
The Revenue Multiple (times revenue) Method
A venture that earns $1 million per year in revenue, for example, could have a multiple of 2 or 3 applied to it, resulting in a $2 or $3 million valuation. Another business might earn just $500,000 per year and earn a multiple of 0.5, yielding a valuation of $250,000.
VCs often use the shorthand phrase “two and twenty” to refer to the 2% of annual management fees a venture fund might take and the 20% carried interest (or “performance fee”) it would charge.
