The Venture Capital Risk and Return Matrix

One of our venture fund managers recently asked, “When you invest, what is a good expected return?” After thinking about the question, we concluded that the answer depends on the type of investment – is it a company or fund, and is it early-stage or late-stage? It is also necessary to account for factors we believe greatly impact returns and their relationship to the ways in which investors underwrite new investments.

Our experience suggests that most venture investors seek a 30% gross internal rate of return (IRR) on their successful investments; according to the National Venture Capital Association, the average holding period of a VC investment is eight years. This means an early-stage investor would need to garner 10x plus multiples on the winners to meet his or her IRR target.

With that in mind, it is clear why holding periods and loss rates are important. A longer holding period will, by definition, require that the top third of investments generates a higher aggregate multiple to achieve the desired IRR, and vice versa. A higher loss rate will also boost the return multiples required from the winners to offset the loss-oriented skew.

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