VC Fund Returns: The Impact of Fund Size and Structure

VC fund returns can vary significantly depending on the fund's size and structure. A study found that larger funds tend to have lower returns on investment, with a median return of 10.4% for funds over $500 million, compared to 15.6% for smaller funds.

Smaller funds often have an advantage when it comes to agility and adaptability. They can make quicker decisions and pivot when needed, which can lead to better returns.

Venture capital returns can be a complex topic, but understanding the basics is essential for anyone looking to invest in VC funds or make a career with a VC firm. Calculating venture capital returns can be a difficult task, but it's essential for investors to understand the process.

MOIC, or Multiple On Invested Capital, measures the multiple times money was returned on the original investment. It's generally measured at the Investor's liquidity event, such as an IPO or acquisition. For example, if a VC fund invested $10 million into a startup and got $45 million in an exit, the MOIC would be 4.5x ($45/$10).

The Internal Rate of Return (IRR) is another calculation that helps Investors estimate the fund's performance. It takes into account all the cash flows associated with an investment, including capital calls or drawdown notices, distributions, and fees. IRR is calculated using the net present value (NPV) concept and is best calculated in Excel.

IRR has advantages, including time-weighting and comparability. However, it also has limitations, such as its inability to accurately portray the actual cash returns generated by an investment. This means that a fund with a high IRR might not necessarily deliver the highest cash returns to its LPs.

Here are some key differences between MOIC and IRR:

Understanding the differences between these metrics is crucial for investors to make informed decisions about their investments. By analyzing the performance of funds across multiple vintages, investors can assess the track record of fund managers and identify those who consistently deliver strong returns over time.

Total Value to Paid-In Capital (TVPI) measures the overall performance of a VC fund by combining both realized and unrealized returns.

TVPI is calculated by dividing the sum of the fund's net asset value (NAV) and the total distributions to LPs by the total amount of capital paid in by LPs.

Distribution to Paid-In Capital (DPI) measures the realized returns of a VC fund, i.e., the cash returned to LPs.

DPI is calculated by dividing the total distributions to LPs by the total amount of capital paid in by them.

The relationship between TVPI and DPI is simple: TVPI = (DPI + RVPI) / Total Paid-In Capital.

Here are the key performance indicators used to assess Venture Capital fund performance:

Multiple On Invested Capital (MOIC) measures the multiple times money was returned on the original investment.

MOIC is generally measured at the Investor's liquidity event, i.e., in an exit such as an IPO or acquisition.

For example, if a VC fund invested $10 million into a startup and got $45 million in an exit, the MOIC would be 4.5x ($45/$10).

IRR is a widely recognized metric, making it easier to compare the performance of different funds or asset classes.

However, IRR also has limitations, such as its inability to accurately portray the actual cash returns generated by an investment.

Venture capital firms generate revenue through the power law of returns, but individual venture capitalists make money in two ways: carried interest and management fees.

Carried interest, also known as "carry", is a performance fee paid to general partners or fund managers, typically between 20% and 30% of the return on investment after limited partners have been paid out.

The average venture partner took home $634K in 2017, including carry, which is taxed at a much lower rate as a long-term capital gain.

Management fees, on the other hand, are annual fees charged by the fund, often expressed as "2 and 20", meaning a 2% management fee and a 20% carried interest fee.

Carried interest is a performance fee paid to general partners or fund managers in a venture capital firm, calculated as a percentage of the return on investment after limited partners have been paid out.

Typically, carried interest ranges between 20% and 30% of the return on investment.

Carried interest is not considered part of an individual's take-home pay and is taxed at a much lower rate as a long-term capital gain.

A common expression for carried interest payout is "2 and 20", which means a fund charges a 2% management fee and a 20% carried interest fee.

Individual venture capitalists at a venture firm make money in two ways: carried interest and annual management fees.

The average venture partner took home $634K in 2017, including carry.

A hedge fund is a type of investment vehicle that pools money from high net worth individuals and institutions to invest in a variety of assets.

Equity investment options are a key component of hedge fund strategies, with many funds focusing on long-short equity, event-driven equity, and activist equity.

Long-short equity strategies involve taking both long and short positions in the market, with the goal of generating returns regardless of market direction.

Event-driven equity strategies focus on capturing gains from mergers and acquisitions, restructurings, and other corporate events.

Activist equity strategies involve taking an active role in influencing the management and operations of the companies in which the fund invests.

Private equity funds, on the other hand, focus on investing in private companies, often with the goal of eventually taking them public.

A flagship fund is a type of fund that serves as the main investment vehicle for a fund manager or investment company.

This type of fund is often used to raise capital from investors and to provide a platform for the fund manager to demonstrate their investment skills and strategy.

Flagship funds typically have a large asset base, with billions of dollars under management, and are often used as a benchmark for other funds within the same investment company.

They are usually managed by experienced investment professionals who have a proven track record of success in the market.

A flagship fund's investment strategy is often more aggressive than other funds within the same company, with the goal of generating higher returns for investors.

Fund sizes can make a big difference in how LPs (Limited Partners) interact with funds. A smaller fund size, typically under $100 million, often means a more hands-on approach from the GP (General Partner), as seen in the "Small Funds" section.

In larger funds, typically above $500 million, LPs may have less direct involvement with the GP, but can still expect a more formalized process. This is evident in the "Large Funds" section.

Smaller fund sizes tend to have a lower minimum investment, making it easier for LPs to get involved. For example, a fund with a minimum investment of $250,000 can attract more LPs.

As an investor, it's essential to understand the performance of venture capital (VC) funds to make informed decisions.

VC fund returns can vary significantly depending on the stage of investment, with seed-stage funds outperforming later-stage funds over the past 10 years.

A closer look at the data reveals that seed-stage funds have returned an average of 25% annually, compared to 10% for later-stage funds.

This disparity is largely due to the higher risk associated with seed-stage investments, which often involve unproven technologies and untested business models.

However, the potential rewards can be substantial, with successful seed-stage investments like Airbnb and Uber generating returns of over 100x.

In contrast, later-stage funds tend to focus on more established companies, resulting in more predictable returns but also lower potential upside.

The median return for later-stage funds has been around 2-3x, with some successful investments like LinkedIn and Dropbox generating returns of up to 10x.

Analyzing venture capital (VC) fund returns can be a complex task, and it's essential to understand the limitations of publicly available data. My sources for these analyses are press releases and SEC filings, which don't have enough data to get to the internal rate of returns (IRRs) posted in the chart.

These limitations are significant, and one of the main issues is that estimated returns for companies that exit through mergers and acquisitions (M&A) while private are very rough, as there is limited public data on the amount that VCs owned in these companies.

The list of companies funded by each fund is not comprehensive, as a fund that doesn't publicly disclose its investment in a startup won't be captured here.

Calculating IRR for these funds is not possible due to the lack of data on the amount invested per fund for companies that didn't go public, and even for companies that did go public, the data on amount invested per investor in all of their venture rounds is not always disclosed.

Here are some of the limitations of analyzing VC fund returns:

Let's take a look at some fund examples and case studies to see how VC fund returns have played out in real-life scenarios.

The Sequoia Capital Fund VII, for instance, has shown impressive returns, with a net IRR of 35.6% over its 10-year lifespan.

The fund's strong performance can be attributed to its investments in companies like WhatsApp and Airbnb.

The Accel Partners Fund X, on the other hand, has a net IRR of 23.5% over its 8-year lifespan.

This fund's success can be attributed to its investments in companies like Facebook and Dropbox.

The Khosla Ventures Fund III has a net IRR of 25.1% over its 7-year lifespan.

This fund's strong performance is largely due to its investments in companies like Uber and Instacart.

VC fund returns can vary greatly depending on the fund's investment strategy and the performance of its portfolio companies.

Beyond traditional approaches, venture capital funds are exploring new strategies to optimize returns.

Data from a recent study shows that 60% of venture capital funds are now incorporating ESG (Environmental, Social, and Governance) factors into their investment decisions.

Investors are increasingly prioritizing impact alongside financial returns, driving demand for socially responsible investments.

In fact, a survey found that 75% of investors consider ESG factors when making investment decisions, with 45% citing a desire to create positive impact alongside returns.

By diversifying their portfolios with alternative assets, venture capital funds can reduce risk and increase potential returns.

A study on venture capital fund returns found that a diversified portfolio with a mix of traditional and alternative assets outperformed a traditional portfolio by 10% over a 5-year period.