Venture Capital Metrics

Venture Capital (VC) metrics play a vital role in evaluating the performance of investments made by venture capitalists. These metrics help investors understand the value they’ve created, assess the potential return, and make future investment decisions. Let’s delve into these metrics and understand their importance.

VC Metrics & Why Are They Important?

VC metrics provide quantitative ways to measure the success or potential of an investment. By assessing these metrics:

Investors can evaluate the performance of individual investments or a portfolio.
They can benchmark performance against other investments or industry standards.
Startups and companies seeking investments can understand the criteria on which they might be evaluated.
It helps in making data-driven decisions on further funding or exits.

VC Fund Performance Metrics

VC Fund Metrics & Why Are They Important?

VC metrics provide quantitative ways to measure the success or potential of an investment. By assessing these metrics:

Investors can evaluate the performance of individual investments or a portfolio.
They can benchmark performance against other investments or industry standards.
Startups and companies seeking investments can understand the criteria on which they might be evaluated.
It helps in making data-driven decisions on further funding or exits.

The Difference Between Multiple and IRR Calculations

Two primary types of VC metrics are used: multiples and rate of return metrics (often using the Internal Rate of Return or IRR).

Multiples: These show how many times the initial investment has increased or decreased in value.
IRR: This represents the annualized rate of return on an investment, considering the time value of money.

Multiple-based VC Performance Metrics

1. Multiple on Invested Capital (MOIC Metric)

Multiple on Invested Capital (MOIC) is a VC metric comparing the current value of an investment to the initial amount invested. It can be evaluated at both the portfolio and deal levels, making it crucial for analysis. MOIC showcases a general partner’s prowess in selecting high-return investments and executing sound investments. Returns with MOIC come from liquidations, without accounting for expenses or fees, and are based on deal costs and capital invested.

2. Gross Total Value to Paid-In Capital (Gross TVPI Metric)

Gross Total Value to Paid-In-Capital (Gross TVPI) is a VC metric highlighting a General Partner’s skill in converting Limited Partner’s investments into significant profits. It measures the current value of investments in a fund and total distributions relative to the fund’s raised capital. This capital is sourced from equity sales, not business operations.

3. Net Total Value to Paid-In Capital (Net TVPI Metric)

Net TVPI is a key VC metric for LPs, differing slightly from Gross TVPI. While Gross TVPI is based on investment returns and book value, Net TVPI considers distributed capital, which encompasses expenses, fees, and carry, and the fund’s book value.

4. Residual Value per Paid-In Capital (RVPI Metric)

Residual Value (also termed Net Asset Value or NAV) per Paid-In Capital measures the unrealized value in an investment. An RVPI of 0.70x means the leftover investments are valued at 70% of the initial dollar. It’s determined by dividing the present value of all investments in a fund by the total amount contributed by Limited Partners.

5. Distributions per Paid-In Capital (DPI Metric)

Distribution to Paid-In (DPI) represents the capital returned to investors relative to a fund’s capital calls as of a specific valuation date. DPI shows the tangible returns achieved by investments up to that date, also known as the realization multiple. Essentially, it indicates how much investors have been paid out, determined by dividing total distributions by the total paid-in capital. This metric is favored by investors as it reveals their actual monetary return.

Rate of return, or time-based performance metrics

6. Gross IRR Metric

Gross IRR evaluates a general partner’s innate investment skill by gauging the returns on invested capital. To calculate Gross IRR outflows, divide Investment Cost/Basis by Paid-In Capital. For Gross IRR inflows, consider Investment Proceeds/Returns and Investment Book Value/NAV.

7. Gross Realized IRR Metric

Gross Realized IRR, akin to Gross IRR, gauges a GP’s talent in executing raw investments. It measures the genuine cash return across all investments, from securities to corporations. Before crunching Gross IRR, it’s crucial to identify whether you’re using invested or paid-in capital, as this choice profoundly influences the result. To compute Gross Realized IRR outflows, inspect the Investment Cost/Basis and Paid-In Capital.

8. Net IRR Metric

This metric evaluates a general partner’s prowess in yielding returns on an LP’s capital inputs. Often cited by GPs, it ranks as the second most vital metric for LPs. Net IRR, akin to net multiples, is best applied at the fund level due to varying methods of apportioning fees, expenses, and calculating unrealized value. For outflows, Net IRR uses Paid-In Capital. Inflows are gauged by considering Distributed Capital and Fund Book Value/NAV.

9. Net Realized IRR Metric

Essential in crafting a J-curve, this is the paramount metric for LPs at a fund’s conclusion, reflecting an investment’s aggregate return or caliber. Unlike other metrics, Net Realized IRR encompasses costs, fees, carried interests, and more that standard IRR omits. Outflows are based on Paid-In Capital, while inflows are gauged via Distributed Capital.

Drawbacks of IRR metrics

A 2004 informal study by McKinsey revealed that only 20% of executives grasped the key limitations of IRR. For example, when comparing two funds, one with an IRR of 24% and another at 11%, it’s tempting to see the first as superior. But there’s nuance missing: IRR doesn’t address reinvestment risks or other investment opportunity redeployments.

IRR Alone Isn’t Sufficient for VC Fund Performance Analysis
Further, since IRR is a percentage, there can be cases where a minor investment boasts a substantial double or triple-digit IRR. In contrast, a more significant investment might only display a single-digit IRR but be more profitable when considering the net present value (NPV).

Fund Operations Metrics

Management Fees: An annual fee, usually 2% of committed capital, paid by the fund to cover General Partner salaries, insurance, and travel.

Escrow: Funds held temporarily by a third party until certain conditions are met, often related to distributions for Limited Partners.

Expenses: Costs incurred by the fund, including legal fees and operational expenditures like annual audits.

Carried Interest: The profit share given to General Partners after a liquidity event, like a company acquisition. Typically, it’s 20% of profits, but can vary based on the GP’s history and fees.

Distributions: Cash or securities given to the fund’s investors, the Limited Partners, after an investment exit. Usually, 80% of distributions go to LPs, but the timing differs across funds.

Valuation Metrics

Fair Market Value (FMV): The worth of an investment at a given time. FMV often changes when a company undergoes a subsequent priced round, setting a new valuation.
Realized FMV: The actual value of an investment realized through events like acquisitions.
Unrealized FMV: The estimated value of an investment not yet actualized through a liquidity event.

Capital Metrics

Committed Capital: The sum a Limited Partner commits to a venture capital fund.
Capital Called: Funds requested from Limited Partners, usually on an as-needed basis for new investments.
Uncalled Capital: Funds committed by Limited Partners but still not requested by the fund.
Total Invested: The cumulative capital invested in portfolio companies, encompassing both initial and follow-on capital.
Capital Remaining: Funds in a fund yet to be invested. Also known as ‘dry powder’ or unspent cash.

Other VC metrics

Hurdle Rate

The hurdle rate is the expected minimum return a venture capital firm or investor aims to achieve before realizing a profit. Typically set by investors or limited partners (LPs), it’s expressed as a percentage signifying the risk-adjusted return acceptable to them.

Why does the hurdle rate matter? It establishes a performance benchmark. If the fund’s return falls short of this rate, investors might not earn profits. For instance, with a 10% hurdle rate, if the fund yields only 9%, investors won’t reap any gains.

Vintage Year

Cash-On-Cash return (COC)

CoC represents the ratio of what a VC earns from an investment exit to the initial investment made in the company. Unlike IRR, the CoC isn’t influenced by the timing of the exit.

Paid in Capital

This is the capital that LPs provide to a fund, commonly referred to as “Contributed Capital”.

Distribution

This represents the cash or stock value returned or distributed by the fund to the LPs.

Residual Value

It’s the residual value of a fund at a specific moment. This is determined by summing up the fair value of all leftover investments and cash equivalents, then subtracting any liabilities.

Total Value (TV)

Total Value (TV) in venture capital represents the combined worth of both realized and unrealized investments within a fund’s portfolio at a given time.