Co-Authored by Vishal Banerjee

At GoingVC we believe in bringing transparency to the venture capital industry. Shedding light on VC fund management, especially launching a venture fund, is a particular area of interest we routinely hear from those within the GoingVC Development program and the broader VC community. 

We decided to take advantage of the GoingVC network and community of VCs to develop the below Venture Capital Fund Model in the hopes this will serve as an illustrative guide for those looking to launch or understand how Venture Funds are structured when it comes to investing capital and modeling returns. You can download the model below:


The Model Details

Model Inputs and Outputs 

The VC Fund model is intended as just that – a model and framework for users to test different inputs and scenarios. Below is an overview of the key assumptions and inputs to the model. Have questions or comments? We would love to hear from you at Team@GoingVC.com.

Fund Size

The total fund size is the commitments from both GPs and LPs. Typically, GPs will commit 1-5% of the total, and we model 2% on average, with the remainder coming from LPs. This figure can be established itself, or be developed by estimating the number of deals and check size. 

Check Sizes

Average check size will reflect the (a) number of investments, (b) the stage of investments and (c) equity stake.  There is good data on the average size of rounds and how they have changed. 

You also need to consider  follow-on investments, where you double-down in portfolio companies. Funds often reserve between 50-66% of the capital for this. Note than in our model we’ve assumed all investments to be independent (i.e. new companies). 

Returns Analysis (Multiple on Investment)

The return on investment you expect to generate from a liquidation events within the portfolio. At the fund level, a standard target multiple is 3x that of the invested capital in the fund. Why a 3x return benchmark over a ten-year fund? Investors are choosing among many options when deciding where to invest their capital. The most common alternative to VC, all else held constant, is simply the stock market. On average, the market, as measured by the S&P 500, has returned 10% per annum. Simple math shows that 10% per year over 10 years grows a $100M portfolio to a value of approximately $260M, or a 2.6x multiple. Factoring in the additional risks associated with Venture investments, a good starting point for a fund is 3x – anything below that figure simply is not worth the additional risk. (Note – this assumes of course a prudent investor is choosing between only VC and equities, whereas in practice the choice would likely include the inclusion of bonds, real estate, and other asset classes that would either increase or decrease the required return). 

This is often why the anecdote that any single VC investment needs to carry the potential for a 10x fund return carries weight and is included in our model. VCs factor in the inevitable failures of their investments. Knowing this and assuming a simple scheme of one-third each of failures, no return (i.e. return multiple of 1x), and success (>1x return), in order to generate a 3x overall fund return, it takes an exceptional return for a few investments. 

The below is a sample portfolio of ten $10M investments and assumes that of the ten, four fail, three return the investor capital, and three are winners of various sizes. Even with two winners of 2x and 3x, there needs to be an exceptional winner to meet the 3x fund return requirement. 

PortfolioInvestmentReturn
Investment 1$10,000,000 $0 
Investment 2$10,000,000 $0 
Investment 3$10,000,000 $0 
Investment 4$10,000,000 $0 
Investment 5$10,000,000 $10,000,000 
Investment 6$10,000,000 $10,000,000 
Investment 7$10,000,000 $10,000,000 
Investment 8$10,000,000 $20,000,000 
Investment 9$10,000,000 $30,000,000 
Investment 10$10,000,000 $220,000,000 




Fund Value$300,000,000 

Multiple3x

The anticipated return is therefore a reflection of the number of exits you are expecting from your portfolio as well as the size of those exits. The return multiple is generally lower the later you invest, as a company has a shorter way to to exit and hence reduced risk. 

The return on your investment depends crucially on how your equity stake will change over the course of your investment – otherwise known as dilution. Research indicates you should account for an average of 20-25% dilution per financing round. So, your equity stake at the time of an exit depends on the stage you made your investment, the number of subsequent financing rounds – with earlier investments getting more diluted through a greater number of rounds. 

Number of Deals & Returns

The estimated number of deals and how those investments expect to perform depends on how selective the GPs intend to be and the characteristics of the verticals in which they intend to invest. This is less a specific company evaluation and more what is expected to happen across all of deals, given the inherent risks in Venture Capital investing. 

In early-stage Venture Capital, a good number of your investments will generate no returns (losers) or breakeven. Fred Wilson talks about what you can expect the breakdown of your investments to be here. Additional research shows that even the best early investors only have a 5-8% success rate in spotting unicorns. 

A word on sourcing – as the average number of deals ranges from 3-4 per year upwards of 20 or more. A decent benchmark is that you’ll invest in around 1% of the companies you source, although some research puts the investment rate even lower. Few VCs invest quickly and from the start. Therefore, it’s generally safe to assume first checks will be written over a 2-3 year period with follow-ons extending throughout the remainder of the fund’s life.

Returns

From our expected returns, company breakdown and check size, we calculate:

Sum of Breakeven companies x $ Investment x Breakeven Multiple on Investment 

+

Sum of Decent companies x $ Investment x Decent Multiple on Investment 

+

Sum of Good companies x $ Investment x Good Multiple on Investment 

+

Sum of Big companies x $ Investment x Big Multiple on Investment

=

Total Expected Cash Returns

Fund Lifecycle

In addition to providing capital, there is plenty of work to do post-investment as good investors help portfolio companies grow to exit. Most exits take at least 8 years from the first financing round and so this is the overall lifecycle of a fund – as returns will not be realized before then. Therefore, the fund lifecycle will usually be 7-10 years for an early-stage fund. 

Management Fee

The “2/20” model is an industry standard – meaning 2% of fund assets are used for general and administrative use (intended to cover the day to day operations of the fund) and 20% of profits are retained by the GPs before the remainder accrues to LPs, known as carry. 

Note that the capital you have to invest should not exceed the total size of the fund minus management fees – this is generally the case unless you are recycling management fees.

Carry

How carry is actually calculated is beyond the scope of those model, but for more information on carry, hurdle rates, clawbacks, and more. Below are a few resources. We assume a simple carry of 20% of profits.

Estimated Cash Flow and Net Multiples

Returns on investments take into account the win/loss probabilities, estimated return multiples, and the number of investments to derive the cash earned from investments and the multiple, which is the ending portfolio value divided by the invested dollars (where the portfolio value is adjusted for fees and GP carry).


Have any questions? We’d love to hear your thoughts! Let us know at team@goingvc.com!

The information contained herein is provided solely for informational and discussion purposes only and is not, and may not be relied on in any manner as legal, tax or investment advice. The views expressed herein are the opinions and projections of the author as of the time of publication unless otherwise noted, and are subject to change based on market and other conditions. The author does not represent that any opinion or projection will be realized.