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! 