Here is a hypothetical example of what a typical VC portfolio could look like and why they need to invest only when they can see a potential for a 10 – 20 times return on their investment. The numbers are overly simplified (see notes) to demonstrate the point of why the Big Profits have to be such a high multiple of the initial investment.

In this example we’ll take a fund of R200 million, which needs to make 20% over 5 years. It makes 20 investments with an average investment of R 10 million.

We also assume that out of every 10 investments that an average VC makes, they’ll have 2 where they loose all their money and fail outright; 3 where they will foresee the company failing and shut it down recovering 50% of cash from selling assets; 4 that will become profitable and make some cash but will never really make it huge; and 1 that will make large multiples on the investment. This seems to be a very rough trend for your average VC but is also simplified for these purposes.

Total | Total loss | 50% loss | 50% gain | Big Profit | Definition |

10 | 2 | 3 | 4 | 1 | Investors average /10 |

20 | 4 | 6 | 8 | 2X | # of investments by fund |

200 | -40 | -30 | 80 | 2X | Millions invested (X is unknown) |

To calculate **X**:

(fund) + (interest) + (tot loss) + (50% loss) = (50% gain) + (Big Profit) [gains must equal loss plus investment and fund]

.: 200 + 40 + 40 + 30 = 80 + 2**X** [ in R millions ]

.: **X** = R 115 million

**.: The fund has to have at least 2 companies sell for over R115 million (over 10 times the investment) for them to make their 20% interest in 5 years.**

** Notes:
- this is an overly simplified example. The following points are some reasons why the final value is a little low…
*

*- The 20% is very low for compound interest over 5 years*

*- R200 mil is on the small side for South African VC funds.*

*- 20 investments is on the high side*

*- Management fees (normally about 15%) are not accounted for*

*This is the Appendix of my Funding Secrets Series.*

Pingback: Funding Secrets Series: VC funding | Roger Norton

Pingback: Funding Secret Series: Overview | Roger Norton