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I went to a VEF session last month where we were told why Venture Capitalists are looking for the “home-run” in all their investments

If I remember it right :

• Investors into VC funds are looking for a 20% annual return on their money

Since I did not write down the math presented at the VEF I had to look around the net or some help. I found the following info on one site:

For every 10 companies you invest in, expect:

• 1 home run (>10x return)
• 1 decent return
• 6 return your original investment
• 2 complete write-offs

which means that if you have $1,000,000 to invest and you split them in 10 equal pots, you should get back

• 1 home run (>10x return) = $1,000,000
• 1 decent return [lets say 2x] = $200,000
• 6 return your original investment = $600,000
• 2 complete write-offs=$0

for a total return, including principal investment, of $1,800,000.

While 80% return sounds good to most of us we must not forget that it might take 10 years to get to this point. So, even if we really simplify and forget about the NPV of money, and then even forget about the IIR the VC’s like to use (Read about some problems with IRR here), it does not take much to figure out that $1.8M does not give a 20% annual return over 10 years. In fact, if we forget about interest on the annual returns (to keep the language in layman’s terms)then $1M will grow to $1.8M after 4 year at the 20% annual interest required by most VC fund investors. $1.8M after 10 years only give $80,000 annually, simplified to 8% annually.

Let’s get back to the VEF presentation… since you never know which investment is going to be the home run, then ALL investments should have the possibility of reaching 10x to make sure that at least one investment reaches this level.

While 2x on an investment might sound great to many of us, it is thus not enough to make up for the losses and and zero-percent returns a VC fund is likely to see.

So, if you find a VC not to be interested in your HOT 3-4x opportunity, you now know why

roar> at roarweb dot com