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How $10 billion returns only 2.5x
The ten billion dollar math
The math runs like this. The firm owns 2 million dollars of equity at a 20 million dollar valuation. The company reaches 10 billion dollars, the firm is diluted by half to 5%, and its stake is worth 500 million dollars. Against a 200 million dollar fund, that is a two and a half times return from a company that became a 10 billion dollar business.
Why outliers rule
A firm of this size might invest in 30 companies. It expects 25 of them to go to zero, three to return two or three times the money, and one or two to become outliers at 30, 40, or 50 times. Those outliers are what make the fund work, and elite funds aim for three, four, or five times.
The pressure on founders
On that math, investors prefer nine of ten companies going to zero and one reaching a billion over five exits at 100 million dollars each. It is why so many people quit venture capital after one or two funds. A founder who tells investors the plan is a quick sale for quick money runs against the pressure they are under.
Why do venture funds expect most bets to fail?
Venture returns follow a power law, where a few investments produce nearly all of the profit. Correlation Ventures analyzed thousands of US venture financings and found roughly two thirds returned less than the money put in. A small slice returned ten times the investment or more, and those carried the results. Funds are therefore built around finding the outlier, and the losses are part of the design.
How does dilution shrink an early stake?
Each priced funding round issues new shares, so existing holders own a smaller percentage afterward. Carta's data shows companies typically sell roughly 15 to 25 percent of themselves in each priced round. Employee option pools add further dilution. An early investor can keep a larger share only by buying into later rounds through pro rata rights.
Why do many investors leave venture after two funds?
A venture fund usually has a term of about ten years, and its results become clear only near the end. A firm raises its next fund every two or three years, often before the earlier fund has returned much. Limited partners judge a first fund on its eventual multiple, and many firms never raise a third. The long feedback loop leaves little room to learn from one fund before the next is due.
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