The math of early stage venture capital

Today I met with an entrepreneur in the travel space that kept reiterating that they wanted to grow organically and without burning money. The “startup” wanted to take it’s a offline business model of booking air tickets, where it earned a respectable profit – online. 

Coming from a strong referral I spent a couple of hours understanding what they did. I concluded that while their current business model was perfect for a family run business they didn’t realise that early stage venture capital would demand that they show rapid growth in the value of the company.

So, I explained to them the following math:

  1. As an early stage venture capitalist I want to build a portfolio of startups that will yield atleast 60% irr.  
  2. So if I put Rs. 100 in 10 startups I have a total portfolio investment of Rs. 1000 
  3. My holding period for an investment is 7 years 
  4. After 7 years the Rs. 1000 investment at 60% irr would turn into Rs. 26,843.50  
  5. I expect 9 out of 10 startups to fail 
  6. Therefore I expect that the return from a single startup will return the Rs 26,843.50 
  7. So, the single investment of Rs. 100 should to return a 122% irr or 268x in 7 years to grow to Rs. 26,843.50!  

At the end I explained to them if their business lacked the potential to growing a rapid pace then early stage venture capital was the wrong form of capital to raise. I think something clicked in their mind when I drew out these numbers and they left thanking me.

I just hope I didn’t scare them off venture capitalists, forever! 

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8 thoughts on “The math of early stage venture capital

  1. I don’t think the math makes a difference. I’ve sat down and done the math and also have shared the “expectations of VC Funds” in a lot of forums. Truth is, a VC fund can “expect” x returns, but there is nothing to hold them to it. Entrepreneurs, if you do the math, just will do models that will convincingly look like it will yield 268X returns so that they can take the cheque and walk off.

    We as a society have always been good at working the system if we know what the end outcome expected is. From Joint Entrance exams, to civil exams to aptitude exercises and question banks our entire society reeks of it, and you just leaked the question paper 😛

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