A venture fund's multiple is earned over the gap between the average call and the average distribution, about 7.7 years here, and that gap sets the IRR.
About 16 per cent, not the 25 per cent people sometimes assume. An illustrative venture fund that calls 100.0 over six years and distributes 300.0 between years 5 and 15 earns a net IRR of 16.0 per cent. The money is out for about 7.7 years on average, and 3.0x over 7.7 years is a mid-teens rate, whatever the fund's ten-year label suggests.
Worked in full in Venture Capital by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Limited partners judge venture funds on two numbers that are often quoted as if they were interchangeable: the multiple, TVPI or DPI, and the IRR. They are linked only through time. A venture fund draws its capital slowly and returns it later still, and the IRR of a given multiple is set almost entirely by the distance between those two streams.
| Input | Value |
|---|---|
| Commitment, all called including fees | 100.0 |
| Calls, years 1 to 6 | 20.0, 25.0, 25.0, 15.0, 10.0, 5.0 |
| Net TVPI at the end of the fund, fully realised | 3.0x |
| Distributions | Years 5 to 15 |
| Share of distributions by year, per cent | 1, 3, 6, 10, 14, 16, 16, 13, 10, 7, 4 |
The distribution curve is a common shape for an early-stage fund: a trickle of small exits, a peak in years 9 to 11 when the winners are sold, and a long tail. It is an assumption, not market data; change it and the answer moves, which is the point of the sensitivity below.
| Year | Called | Distributed | Net flow | DPI |
|---|---|---|---|---|
| 1 | 20.0 | 0.0 | −20.0 | 0.00x |
| 2 | 25.0 | 0.0 | −25.0 | 0.00x |
| 3 | 25.0 | 0.0 | −25.0 | 0.00x |
| 4 | 15.0 | 0.0 | −15.0 | 0.00x |
| 5 | 10.0 | 3.0 | −7.0 | 0.03x |
| 6 | 5.0 | 9.0 | 4.0 | 0.12x |
| 7 | 0.0 | 18.0 | 18.0 | 0.30x |
| 8 | 0.0 | 30.0 | 30.0 | 0.60x |
| 9 | 0.0 | 42.0 | 42.0 | 1.02x |
| 10 | 0.0 | 48.0 | 48.0 | 1.50x |
| 11 | 0.0 | 48.0 | 48.0 | 1.98x |
| 12 | 0.0 | 39.0 | 39.0 | 2.37x |
| 13 | 0.0 | 30.0 | 30.0 | 2.67x |
| 14 | 0.0 | 21.0 | 21.0 | 2.88x |
| 15 | 0.0 | 12.0 | 12.0 | 3.00x |
| Total | 100.0 | 300.0 | 200.0 | 3.00x |
Net IRR: the rate at which the net flows discount to zero. In Excel: =IRR(D2:D16) returns 16.0%.
Average call date = Σ(year × call) ÷ Σcalls = 2.9; average distribution date = 10.5
Shortcut = 3.0^(1 ÷ (10.5 − 2.9)) − 1 = 3.0^(1 ÷ 7.7) − 1 = 15.4%
The shortcut treats the fund as a single investment held for 7.7 years and lands within a point of the true figure; it runs slightly low because spreading the flows around their average dates favours the IRR. It also explains the two figures people quote by mistake. Treating 3.0x as earned over the ten-year legal life gives 11.6 per cent, too low; treating it as earned over a five-year holding period gives 24.6 per cent, far too high. A fund's capital is not invested on day one, and it does not come back on day ten.
Rule of thumb: when calls run over five or six years and exits peak around years 9 to 11, the money is out for seven to eight years on average. At 7.7 years the shortcut gives 9.5 per cent for 2.0x, 15.4 for 3.0x and 23.4 for 5.0x; the full cash flows here come out a little higher, at 9.7, 16.0 and 24.7.
| Net TVPI | Starts year 4 | Starts year 5 (base) | Starts year 7 |
|---|---|---|---|
| 1.5x | 6.4% | 5.5% | 4.3% |
| 2.0x | 11.3% | 9.7% | 7.5% |
| 3.0x | 18.8% | 16.0% | 12.3% |
| 5.0x | 29.5% | 24.7% | 18.7% |
Two years of slower exits take a 3.0x fund from 16.0 to 12.3 per cent, the same IRR as a fund returning 2.4x on time. One year of delay alone costs 2.1 points here; the general case is worked in how much a one-year delay in distributions cuts a fund's IRR. For an LP choosing between managers, a high multiple achieved late and a lower one achieved early can be the same investment.
The common mistake is to compare a venture fund's multiple with a buyout fund's IRR, or the reverse, using a holding-period rule that belongs to a single deal. Converting 3.0x at five years, as one would for a buyout company, says 24.6 per cent; the fund earned 16.0. The second mistake is reading the IRR before year 10. At the end of year 9 this fund has paid back 1.02x and two thirds of its distributions are still to come, so any interim IRR rests on a valuation of unrealised companies, not on cash.
Which multiple the 3.0x is also matters. The figure here is net to the limited partner, after fees and carried interest. The gross multiple needed to deliver it is much higher, as what gross multiple a VC fund needs to return 3x net shows.
A 3x net venture fund earns about 16 per cent a year when its capital is out for 7.7 years on average, and anywhere from 12 to 19 per cent as the exits slip or arrive early. Quote the multiple and the IRR together, and the average duration that links them. The book's fund, with its fee schedule, carry and the ladder that puts the multiple and the IRR on the same denominator, is reproduced in the free workbook for this case.
It depends on the multiple and the timing together. In this illustrative cash flow pattern a 2.0x net fund earns 9.7 per cent, a 3.0x fund 16.0 per cent and a 5.0x fund 24.7 per cent. Because venture capital is out for close to eight years on average, a net IRR in the mid-teens already requires about 3x net.
Find the average date of the calls and of the distributions, each weighted by amount, and take the multiple to the power of one over the gap. Here the calls centre on year 2.9 and the distributions on year 10.5, a gap of 7.7 years, so 3.0x gives about 15.4 per cent, against 16.0 from the full cash flows. Use the real flows in Excel for anything reported.
In this illustrative pattern DPI passes 1.0x in year 9, at 1.02x, after distributions of 3.0 in year 5, 9.0 in year 6, 18.0, 30.0 and 42.0. About two thirds of the 300.0 still arrives after that point, which is why interim IRRs on a venture fund say little before year 10.
This article is one calculation from Venture Capital. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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