Portfolio Returns - What VC's Are Looking For ...

Fund raising by VC's has been a difficult task recently, as we know. Which prompted me to do a little research on what expectations limited partners (the investors in the VC funds) have for their money. I'm indebted to views shared by Susan Mason at Onset Ventures at the SVASE event a couple of weeks ago, and Fred Wilson's blog, A VC, earlier this year (Fred is a partner at Union Square Ventures, an investor in Twitter and some other very interesting companies and one of the smartest investors out there)

In order to raise money VC's have to offer superior returns versus the investment alternatives for their limited partners. We know VC investing is risky and for a limited partner the money is in there for a long period of time (no, they can't pull it out when the market crashes or other misfortunes occur). So those returns need to be quite substantial to attract the billions that flow into this kind of investment vehicle and then have to wait it out.

As it turns out the returns needed are in the order of 20% per annum over the life of an investment in a specific fund - after the VC's get their cut in management fees and their "carry" (share of the portfolio). Put another way, over a typical fund life this turns out to be about 2.5x their original investment. If you invested $10m in a VC fund it would deliver $25m in returns (after the VC fees and carry) when the fund is liquidated after 10 years. Not shabby - if it happens.

On the VC side, then, how do the individual investments need to perform in a portfolio to deliver this kind of return? As an early stage investor Fred Wilson expects to lose all his money on 1/3 of his investments, get his money back or a little more on another 1/3 and make all of the fund returns on the remaining 1/3. Which means the latter have to do really well - about 7.5x the amount invested.
This in fact will range from maybe 2x to 15x per "successful" investment, but you get the picture. 

So in a $250m portfolio of maybe 25 investments, roughly 8 would have zero returns, another 8 might return $80 - $100m in total, and the remaining 9 would have to generate roughly $650m which would come in the range from $15m to $150m. That is not an insubstantial task. But then VC's are highly incented to make it happen!

Of course a VC takes a portfolio approach. An entrepreneur can't. So while a VC can be OK with doing well on one of every three investments, you as an individual need to make the one you're working on defy the odds stacked against you.