IRR Multiplication Table – What Drives Venture Capital Investments

This is probably one of the most useful tables around (via Will Price).  I’ve heard some VCs carry this around with them.

I thought of this after reading this post about some former entrepreneurs raising a new fund:

Josh Felser and Dave Samuel –  a team of entrepreneurs who’ve founded and sold two startups for hundreds of millions of dollars –  are getting into the early-stage venture capital business, and they’ve established some nontraditional objectives toward that end. “Ideally, we’re looking to invest in startups that raise less than $5 million from investors, and that get sold in less than five years,” says Felser.

“Venture capitalists are always aiming to hit that home run investment. We’re trying to hit triples and think we’ll be better off for it,” he says.

The firm, Freestyle Capital, joins a select but growing number of firms that have begun investing small funds in seed and early-stage companies in recent years, including First Round Capital and Maples Investments, both of which were also founded by successful entrepreneurs. First Round’s Josh Kopelman founded, which sold to eBay for $350 million in 2000; Maples cofounded the broadband software company Motive, which went public in 2004.

So if you look at the IRR table, tech deals have been taking an average of 6-7 years to exit, which is why you have to shoot for a 10x exit.  If these guys are looking at shorter exits in the 5 year time frame, they need to shoot for a 6x return (but expect something lower).

So the IRR math model doesn’t change.  They are just moving to shorter time frame, which allows them to ask for lower multiples.  BUT, this all implies smaller deals, smaller funds, and fewer investors.

Still, I’m a huge fan of VC going back to small ball.  I think there’s a lot more room for growth out there for these small funds (at least in the online/tech space).

6 thoughts on “IRR Multiplication Table – What Drives Venture Capital Investments

  1. i have done several startups with all sucessful exits. the game is about multiple triples. the home run or IPO is over. i’d rather have multiple medium sells that one 10 year exit. better for the local economy, better experience, higher churn, more experiences.

    people found companies to sell them to yahoo,google,microsoft,ibm,cisco.

    nothing else.

  2. you have to net out 2.5% each year in fees and expenses, plus th 20% carried interest to find out net returns to investors.

  3. sameet, you are exactly right.

    and that brings up a point i want to make– a lot of people don’t realize that if you’re raising a 100mm fund, after fees over ten years, you have what… 80mm left to put to work.

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