VC Fund Economics

Shortening VC Learning Cycle

Do you want to start your own VC fund and invest in early-stage ventures, but have you ever wondered how VCs build their fund economics, and LPs track VCs fund performance? What are the things to look at, what to follow, what LPs want? 

At the very least, we all should be knowing these terms - TVPI, DPI, and IRR - How to calculate them and what are their significance. 

• TVPI: Total Value to Paid In capital multiple
  "Quick example, let's say a VC has a $100M fund. If they have called 50% of the capital ($50M), returned $20M to their investors from exits, and the remaining portfolio is worth $55M, then TVPI = ($20 + $55) / $50 = 1.5."

• DPI: Distributions to Paid-in Capital multiple: "This is how much money a VC fund has sent back to LPs divided by the amount of money the LP has paid into the fund." 

• IRR: Internal Rate of Return: As well all know, it's kind of a fake number at the initial stages of the fund - since most or none of the private stock is not liquid.

Cambridge Associates, have gathered much data from a wide range of VC and PE funds and publishes benchmark data of their performance regularly. Here are a few links to the reports:  

• https://www.cambridgeassociates.com/wp-content/uploads/2019/11/PEVC-Impact-Investing-Benchmark-Statistics-2019-Q2.pdf

• https://www.cambridgeassociates.com/wp-content/uploads/2019/11/WEB-2019-Q2-USVC-Benchmark-Book.pdf

• https://www.cambridgeassociates.com/wp-content/uploads/2019/11/WEB-2019-Q2-ExUS-Dev-EM-Selected-Book.pdf

• https://www.cambridgeassociates.com/wp-content/uploads/2019/11/Real-Assets-Impact-Investing-Benchmark-Statistics-2019-Q2.pdf
  

The data from Cambridge Associates indicate a fascinating story about VCs-

• VCs are not necessarily making money, 

• DPIs are pretty low, and TVPI is also less than 3, which means even the top-performing VC funds are also not able to get 3X exits at fund level on paper. 

• This asset class, i.e., investing in private companies at an early stage, is precarious, and even if the fund returns 2X in 10 years, which means IRR of 10%, it is not a very high return asset class. 

To know more, read this on How VC asset class is doing? DPI looks pretty bad (It almost takes seven years at least to give back 1X to the LPs). Even, the top-performing funds, DPI in 7 years is less than 1. 

On the other note, it is essential to understand how tough it is to get a 10X return on investment as a VC. Please do give it a read to this article. 

Key takeaways: 

• Focus on power-law outlier companies.

• Maintain and Buy ownership cost-effectively (earlier the better)

• Keep fund size to a reasonable level relative to their targets.

This article covers pieces around how dilution works, how it affects the overall return, and why we should be a bit careful about follow-ons. 

Bonus content, wanting to read how to start an early-stage micro-fund, and how tough is it? Why doesn't it make economic sense? Why it makes sense to keep the team lean? Etc. 

I am continuously looking for first-time funds and first-time fund managers who are looking to create their first-time impact funds with an edge or a differentiated value proposition in emerging economies. If you are building one, please do write to me. I would love to learn more from you and would be happy to help in any way.

With Love,

Sagar

About

"first followers" is founded by Sagar Tandon, a founding member at Moonshot Ventures. You can reach him at sagar@moonshotventures.org.

Occasionally, he blogs about the responsible investing, tech for good, venture capital, investment thesis, conscious capitalism, collaborative consumption, community, and humane lifestyle.