How Much Does a VC Need to Make?

Musing about venture capital return assumptions

December 2021. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Venture capital funds are highly sensitive to exit multiples given the skewed ratio of winners vs losers
  • The average venture capital fund has achieved the same return as the Nasdaq since 2001
  • The growth expectations for startups increase significantly when assuming a market correction like in 2000

INTRODUCTION

The beauty of financial markets is that they continuously surprise, but some years are more extreme than others. In 2017 Argentina issued a 100-year bond that seemed surreal given that the country just emerged from a default a year earlier, and was anything but a credit-worthy model economy. However, compared to the transactions happening in crypto space in 2021, eg an invisible rock JPEG selling for $12,800 or a video game yacht for $650,000, the Argentinian century-bond seems almost like a sensible investment.

Most of these unusual transactions in recent years can be attributed to the low-interest rate regime that made trillions of bonds unattractive and investors looking for greener pastures. The venture capital industry has been one of the key beneficiaries of this theme as it promises high growth of capital in a low-growth world. The assets under management are at record highs, which is mirrored in the number of unicorns startups that breached 800 in 2021. The more money available to a venture capitalist, the more can be invested, the higher the valuation, the better the returns, and the flywheel spins. Until it breaks (read Venture Capital: Worth Venturing Into?). 

In this research note, we will muse about the return assumptions of venture capital funds.

SEED-STAGE VENTURE CAPITAL FUNDS

The venture capital industry has, like all industries, its own terminology that evolves over time. The funds that invest in early-stage startups are also called seed funds and portfolios tend to be quite diverse. Some companies have found product-market-fit and are generating revenues, while others are still at the concept stage. The valuation for this type of startup has increased considerably in recent years, in line with the amounts of money they are raising, for what often is still an experimental business.

The tr