VC's pour money into unprofitable startups like Uber for years. Ever wonder how they make money? There are many different stages of VC investment, for the below we will look at funds that deal with early stage companies. They invest in companies that are just an idea, through to a little bit of traction and revenue. 📈 How They Generate Returns VC firms create funds that investors can put their money into, in the early stage these funds are $5m to $50m. VC firms use those funds to invest in startups that they believe will 'return the fund' - if this company succeeds then it doesn't matter if every other investment fails. They do this because most fail. Here is what 100 investments could look like: ‣ 65 go to zero - the company fails ‣ 25 return 1x to 5x - surviving but not thriving ‣ 9 return 5x to 10x - a successful investment ‣ 1 returns 10x+ - the unicorns Assuming a $500k investment in each: ‣ $32.5m down the drain ‣ $12.5m invested, $31.3m returned = $18.8m up ‣ $4.5m invested, $33.8m returned = $29.3m up ‣ ??? Without the unicorn, the fund is up $15.6m. Seems like a lot but the time horizon is 10 years, once you take out management fees, it is a tiny annual return on $50m. But that 1 unicorn can return $50m and that's what they're banking on. 💰 How The Funds Profit Funds typically charge investors a 2% annual management fee for invested capital. The VC invests that $50m across 100 businesses, they will charge investors $1 million a year to manage it. Over the 10 year investment period thats $10 million. They use this to pay employee salaries & overheads. They also take 20% of the returns, known as carry. The VC will make 20% of any profitable exit. On that unicorn, they will make $10m on the $50m exit. This goes to General Partners (GPs) of the firm. --- Using the Uber example - Benchmark Capital invested $12m in 2011*. Their fund size was $425m. By the time of the Uber IPO, Benchmark's stake was valued at approximately $7 billion. Benchmark charges investors a 30% carry fee. If the rest of Benchmark's investment's failed (they didn't) they still would have made $2.1 billion in carry fees. *there were subsequent investments though the amounts have not been disclosed.
Dr Tanvir Uddin
4mo
Archer Sampson sounds like starting a VC is the next get-rich-quick scheme!
VC Investor | Investible
4moArcher good explanation. The power laws as they apply to VC is a very real construct. As for GP returns on distributions, they are subject to a minimum hurdle rate that must be met, typically 8% IRR