EntrepreneursVenture Capital

Explained: VC target returns

By May 11, 2007 7 Comments

I get asked a lot about the returns that we target, so I thought I’d get some thoughts down here for y’all.

The short answer is that to make good money in venture capital you need to be producing home runs and that means targeting big returns on every deal.

The numbers work out this way because in order to produce decent returns for our investors (Limited Partners or LPs) we need to be doubling or tripling our funds, i.e. returning £400-600m on a £200m fund. By the time you factor in the time it takes to invest in, grow and sell companies, the costs of running a VC partnership and our profit share even turning £200m into £600m only generates IRRs in the 25-30% range (depending on how long it takes). LPs would be happy with that, but not ecstatic, the best venture funds do better.

The other important thing to note is that LPs need to believe we can deliver these sorts of returns to justify the risk of investing in venture capital at all – the majority of funds don’t get anywhere near this level.

As a point of comparison LPs can also choose to invest in 100% safe bonds for returns of c5-7% or public equities for returns nearer the 10% mark.

OK – so to generate good returns for our LPs we need to triple our fund. Doing that on a £200m fund with 20 investments of £10m would look something like this:

  • Three deals making 10x returning £300m
  • Three deals making 5x returning £150m
  • Three deals making 3x returning £90m
  • Six deals where you get your money back returning £60m
  • Five deals where everything is lost

Add that up and you get 20 deals returning £600m. I tried to put this in a table for you but couldn’t get it to work….

You can play about with the split between 10x, 5x, and 3x returns, or even put in a Skype like deal at more than 10x, but the underlying message is clear – to have good returns you need a couple of good home runs. Unfortunately we don’t hit a home run anything like every time :(, so we need to believe that just about every deal we do has the potential to get us a 10x return.