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.*

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You hear a lot these days about the Series A Crunch, how the search for VC funding is getting more difficult and entrepreneurs are facing more and more competition when they pitch their companies to investors. Here are some of their secrets

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