Rates of Return and Investment Periods
Each
stage has its own set of funding
criteria and its own group of individuals who work in that field. The earlier
the financing stage, the greater the risk, the greater expected return, and the
greater percentage private investors and venture capitalists will request.
Sometimes the investor will require control of up to 80% of the company.
Entrepreneurs, however, are usually
given the opportunity to earn back controlling interest if certain
milestones and performance standards are met. Also, the earlier the stage,
the more difficulty will be encountered in raising the initial capital. It may
take six months to a year to locate the proper partner for your business.
General guidelines for venture capital
investment returns are:
Start ups, 10-12 times return in 5-7
years.
Existing early stage companies, 5-7
times investment in 4-5 years.
|
Cash Returns, Investment
Periods, and Rates of Return |
|
Return |
Investment Period |
|
2 yrs |
3 yrs |
4 yrs |
5 yrs |
6 yrs |
7 yrs |
8 yrs |
|
2 x |
41.4% |
26.0% |
18.9% |
14.9% |
12.2% |
10.4% |
9.1% |
|
3 x |
73.2% |
44.2% |
31.6% |
24.6% |
20.1% |
17.0% |
14.7% |
|
4 x |
100.0% |
58.7% |
41.4% |
32.0% |
26.0% |
21.9% |
18.9% |
|
5 x |
123.6% |
71.0% |
49.5% |
38.0% |
30.8% |
25.8% |
22.3% |
|
6 x |
144.9% |
81.7% |
56.5% |
43.1% |
34.8% |
29.2% |
25.1% |
|
7 x |
164.6% |
91.3% |
62.7% |
47.6% |
38.3% |
32.0% |
27.5% |
|
8 x |
182.9% |
100.0% |
68.2% |
51.6% |
41.4% |
34.6% |
29.7% |
|
9 x |
200.0% |
108.0% |
73.2% |
55.2% |
44.2% |
36.9% |
31.6% |
|
10 x |
216.2% |
115.4% |
77.8% |
58.5% |
46.8% |
38.9% |
33.4% |
|
11 x |
231.7% |
122.4% |
82.1% |
61.5% |
49.1% |
40.9% |
35.0% |
|
12 x |
246.4% |
128.9% |
86.1% |
64.4% |
51.3% |
42.6% |
36.4% |
Why are expected returns so high?
Quite simply because of all the
non-performing investments, or losses and the lack of liquidity and the
availability of other opportunities. The compounded Venture Capital Return
Rate over many years is approximately 17.8%. In order for a Venture Fund
to be profitable, it must assume at least 50% of its investments will at best
make only a small profit. Approximately 25% of the investments will be
sold or liquidated. Of the remaining 25%, about half will go public and
generate compounded returns exceeding 60-120%. For a portfolio of 20
companies, only one will be a "rocket" or "home run" and provide the 10 - 100
times Return on Investment that everyone is looking for.
Valuations
and
due diligence should be made by both parties in
order to accurately determine the amount and
type of debt and
equity
that will optimize the investment for both the entrepreneur and the investor.
Follow-on stages of financing should also be considered. The importance of the
cost of capital and the eventual amount of equity dilution to you and your
initial shareholders cannot be overstated.
Besides Venture Capital, there are
more than 30 methods of funding your business that do not require venture
capital to finance your operations.
