# Venture Capital Portfolio Construction Concept Card: [Your fund, case or course] > A concept card for how a venture capital fund turns a pool of commitments into a portfolio: investable capital after > fees and expenses, recycling, the number of companies, initial cheque size and entry ownership, reserves for > follow-on rounds, dilution to exit, the "fund returner" test, and why power-law outcomes make diversification and > concentration behave differently than in public markets. It is for second-year MBA students in a venture capital > elective, candidates recruiting for venture and growth roles, founders who want to understand how their investors > think, and LPs reviewing a venture fund. It builds on mba/mba-venture-finance-cap-table-card, which explains pre- and > post-money valuation, dilution and liquidation preferences for one company; this card applies the same arithmetic > across a whole fund. Worked example A builds a fictional USD 150m seed and Series A fund ("Fund I") with a computed > portfolio and a simulation; Worked example B is half solved and Exercise C is left for you, with a separate answer > key. Source basis: Sahlman (1990), Gompers and Lerner (1999), Cochrane (2005), Kaplan and Schoar (2005), Metrick and > Yasuda (2010), Korteweg and Sorensen (2010), Kerr, Nanda and Rhodes-Kropf (2014) and Gompers, Gornall, Kaplan and > Strebulaev (2020), written up in original words. Replace every [bracketed] value and every row marked *Example*. > This is a learning aid, not investment, legal or tax advice. ## Document control | Field | Value | |---|---| | Course, case or fund | [Venture capital elective, session 5 / Fund name and vintage] | | Learner or analyst | [Your name] | | Strategy | [Stage, sector, geography, lead or follow investor] | | Fund size and terms | [Commitments, fee schedule, expenses, recycling limit, carry] | | Outcome assumptions | [Source: fund's own history, published industry data with date, or stated judgement] | | Reviewed by | [Study partner, tutor or venture investor] | | Version | [0.1] | | Last updated | YYYY-MM-DD | ## Contents - [When to use it](#when-to-use-it) - [The idea in plain language](#the-idea-in-plain-language) - [Formulas and notation](#formulas-and-notation) - [Assumptions and limits](#assumptions-and-limits) - [How venture investors and LPs use it](#how-venture-investors-and-lps-use-it) - [Worked example A (fully solved): Fund I, USD 150m](#worked-example-a-fully-solved-fund-i-usd-150m) - [Worked example B (half solved): follow-on or a new company](#worked-example-b-half-solved-follow-on-or-a-new-company) - [Exercise C (unsolved): design a USD 50m seed fund](#exercise-c-unsolved-design-a-usd-50m-seed-fund) - [Portfolio construction process](#portfolio-construction-process) - [Connections to other cards](#connections-to-other-cards) - [Common mistakes and misconceptions](#common-mistakes-and-misconceptions) - [Self-test questions](#self-test-questions) - [My notes and next steps](#my-notes-and-next-steps) - [Sources and further reading](#sources-and-further-reading) - [Answer key](#answer-key) - [Revision history](#revision-history) ## When to use it **One-sentence rule:** because a few companies produce most of a venture fund's proceeds, portfolio construction is the design of a capital budget (how many companies, how much each, how much held back for winners) that gives the fund enough chances to own a meaningful share of an outlier and enough money to keep that share as the outlier grows. | Use this card when | Use another card when | |---|---| | You design or review a venture fund's strategy (size, cheque size, number of companies, reserves) | You value one start-up for a round (mba/mba-vc-method-card) | | You decide whether to use reserves on a follow-on or on a new company | You negotiate the terms of one round (mba/mba-term-sheet-card) | | You test whether a target exit can "return the fund" at your ownership | You model one company's cap table and waterfall (mba/mba-venture-finance-cap-table-card) | | You explain to an LP why a fund with many failures can still return 3x | You compute LP net returns from fees and carry in detail (mba/mba-pe-fund-economics-card) | | You compare venture risk with public-market diversification | You build a mean-variance portfolio of listed assets (mba/mba-portfolio-theory-card) | ## The idea in plain language A venture fund raises commitments from LPs, but not all of that money reaches companies. **Management fees** over the fund's life and **fund expenses** come out first; some funds **recycle** early proceeds back into investments, which adds capital back. What is left is **investable capital**. The GP splits it into **initial cheques**, the first investment in each company, and **reserves**, money held back to buy more in later rounds of the companies that do well. Each initial cheque buys an **entry ownership**: cheque divided by post-money valuation. Every later round issues new shares and **dilutes** that ownership, unless the fund uses its **pro rata right** to buy its share of the new round. What matters at exit is **exit ownership** times **exit value**. Venture outcomes are highly skewed. Many companies return less than their cost, and a small number return many times it. Sahlman (1990) described this skew and the staged financing that venture contracts use to manage it; Kerr, Nanda and Rhodes-Kropf (2014) frame venture investing as experimentation in which most experiments fail and investors learn by funding stages. Cochrane (2005) and Korteweg and Sorensen (2010) estimated the risk and return of venture investments while correcting for the fact that values are observed only when companies raise money or exit. For portfolio design, the skew has two consequences: - **The fund-returner test.** A partner asks of each new company: if this company succeeds, can our stake in it return the whole fund? The answer depends on exit ownership, so cheque size and reserves matter as much as picking. - **Diversification works differently.** In public markets, more holdings reduce risk around a similar expected return. In venture, more companies (at the same total capital, so smaller cheques) raise the chance of holding an outlier and pull the median fund outcome up towards the mean, but each outlier is a smaller share of the fund. The chance of a very high fund multiple can fall with too many small positions, while the chance of losing money falls steadily. Gompers, Gornall, Kaplan and Strebulaev (2020) surveyed venture capitalists and reported that they see the management team as the most important factor in selection, that few use discounted cash flow, and that many set target multiples; portfolio construction is how those beliefs become a capital plan. ## Formulas and notation $$ K_{inv} = C - F_{life} - X + Rc \qquad K_{inv} = n \times k + Q $$ $$ s_0 = \frac{k}{V_{post}} \qquad s_{exit} = s_0 \prod_{j=1}^{J} (1 - d_j) \qquad d_j = \frac{\text{new money in round } j}{\text{post-money of round } j} $$ $$ V^{*}_{exit} = \frac{C}{s_{exit}} \qquad \text{(exit value at which one company returns the fund)} $$ $$ \text{Gross multiple on invested capital} = \frac{\sum_i P_i}{\sum_i (k_i + q_i)} \qquad \text{Net TVPI} = \frac{\sum_i P_i - Rc - \text{Carry}}{C} $$ | Symbol | Meaning | Unit | |---|---|---| | $C$ | Fund commitments | Currency | | $F_{life}$ | Management fees over the fund's life | Currency | | $X$ | Fund expenses (legal, audit, administration) | Currency | | $Rc$ | Recycled proceeds reinvested instead of distributed | Currency | | $K_{inv}$ | Investable capital | Currency | | $n$, $k$ | Number of initial investments and initial cheque size | Count, currency | | $Q$ | Reserves for follow-on rounds; reserve ratio $= Q / (n k)$ | Currency | | $V_{post}$ | Post-money valuation of the round in which the fund enters | Currency | | $s_0$, $s_{exit}$ | Entry and exit ownership (fully diluted) | Ratio | | $d_j$ | Dilution in later round $j$ for a holder who does not participate | Ratio | | $P_i$ | Proceeds from company $i$ | Currency | | $k_i$, $q_i$ | Initial and follow-on investment in company $i$ | Currency | The net TVPI formula assumes the fund is fully realised and all commitments are called; carry here is a share of distributable proceeds above commitments. mba/mba-pe-fund-economics-card shows the full waterfall. ## Assumptions and limits 1. **Outcome distributions are uncertain.** The scenario and simulation below are illustrations, not industry statistics. Use the fund's own history or a dated published dataset, and state the source. 2. **Outcomes are not independent.** Companies in the same vintage share the same funding market and exit window, so the real spread of fund outcomes is wider than an independent simulation suggests. 3. **Dilution varies.** The examples use fixed dilution per round; real rounds dilute between a few percent and a third or more, and down rounds or option pool increases change the picture (mba/mba-venture-finance-cap-table-card). 4. **Preferences change proceeds.** Exit proceeds equal ownership times exit value only when preferred shares convert to common. In modest exits liquidation preferences change who gets what (mba/mba-term-sheet-card). 5. **Reserves are a forecast.** The GP cannot know which companies will need follow-on money; unused reserves lower deployed capital and the fund's multiple on commitments. 6. **Fees and recycling depend on the LPA.** Fee schedules, expense caps and recycling limits differ from fund to fund. 7. **Time matters.** Venture exits often come late in the fund's life; a high multiple earned over twelve years is a modest IRR (mba/mba-npv-irr-card). ## How venture investors and LPs use it **Fundraising.** A GP presents a portfolio construction model to LPs: fund size, target number of companies, initial cheque range, target entry ownership, reserve ratio and the outcome scenario that gets to the target net multiple. LPs test consistency: can a USD 150m fund lead seed rounds and keep meaningful ownership through Series B with the reserves it plans? **Each new investment.** The partnership asks whether the company passes the fund-returner test at the planned ownership, whether the cheque fits the budget, and how much reserve to earmark for it. **Each follow-on decision.** Reserves are scarce. Each follow-on should be judged on its own expected return at the new price, compared with the alternative of a new initial cheque (Worked example B), and not on loyalty or on the wish to avoid a signal of non-support. **Monitoring.** The GP tracks deployment against plan (capital invested, reserves left, companies added) and reports to LPs in a quarterly report (finance/lp-quarterly-report). LPs compare TVPI and DPI with funds of the same vintage and strategy, and read portfolio concentration: how much of NAV sits in the top three companies. ## Worked example A (fully solved): Fund I, USD 150m **Situation (fictional).** Fund I has USD 150m of commitments and a ten-year life. It is an illustration for this card: the USD 150m Fund I of the mba/mba-venture-capital-guide mini-case has a stepped-down fee and about 25 companies, so its budget differs. Terms: management fee 2.0% a year on commitments for ten years, fund expenses USD 3m, recycling of USD 10m of early proceeds, carry 20% of distributable proceeds above commitments. Strategy: 30 initial cheques of USD 2.0m each, at a typical seed post-money of USD 16m. Later rounds dilute non-participating holders by 20% (Series A), 18% (Series B) and 15% (Series C). **Step 1: capital budget (USD m).** | *Example* item | Computation | Result | Excel formula | |---|---|---|---| | Lifetime fees | $150 \times 2\% \times 10$ | 30.0 | `=150*2%*10` | | Expenses | | 3.0 | given | | Recycling | | 10.0 | given | | Investable capital | $150 - 30 - 3 + 10$ | 127.0 (84.7% of commitments) | `=150-30-3+10` | | Initial cheques | $30 \times 2.0$ | 60.0 | `=30*2` | | Reserves | $127.0 - 60.0$ | 67.0 (52.8% of investable) | `=127-60` | | Reserve ratio | $67.0 / 60.0$ | 1.12 per dollar of initial cheque | `=67/60` | **Step 2: ownership and the fund-returner test.** | *Example* item | Computation | Result | Excel formula | |---|---|---|---| | Entry ownership | $2.0 / 16.0$ | 12.50% | `=2/16` | | Exit ownership, no follow-on | $12.5\% \times 0.80 \times 0.82 \times 0.85$ | 6.97% | `=12.5%*(1-20%)*(1-18%)*(1-15%)` | | Pro rata cheque in Series A (round USD 12m at USD 60m post) | $12.5\% \times 12$ | 1.50 | `=12.5%*12` | | Exit ownership with pro rata in Series A | $12.5\% \times 0.82 \times 0.85$ | 8.71% | `=12.5%*(1-18%)*(1-15%)` | | Exit value that returns the fund, no follow-on | $150 / 6.97\%$ | 2,152.1 | `=150/6.97%` with the unrounded cell | | Exit value that returns the fund, pro rata in A | $150 / 8.71\%$ | 1,721.7 | `=150/8.713%` with the unrounded cell | | Exit value for 3x the fund from one company, pro rata in A | $450 / 8.71\%$ | 5,165.0 | `=3*150/8.713%` | A USD 1.5m pro rata cheque in Series A lowers the exit value needed to return the fund from about USD 2.15bn to about USD 1.72bn. That is the logic of reserves. **Step 3: an outcome scenario (USD m).** Reserves go mostly to the companies that raise later rounds. The multiples are illustrative. | *Example* outcome group | Companies | Invested per company (initial + follow-on) | Total invested | Multiple on invested | Proceeds | Share of proceeds | |---|---|---|---|---|---|---| | Write-off | 15 | 2.0 + 0.6 | 39.0 | 0.0x | 0.0 | 0.0% | | Return about cost | 8 | 2.0 + 1.5 | 28.0 | 1.0x | 28.0 | 5.6% | | Solid | 4 | 2.0 + 4.0 | 24.0 | 2.5x | 60.0 | 12.0% | | Strong | 2 | 2.0 + 9.0 | 22.0 | 6.0x | 132.0 | 26.4% | | Fund returner | 1 | 2.0 + 12.0 | 14.0 | 20.0x | 280.0 | 56.0% | | Total | 30 | | 127.0 | 3.94x | 500.0 | 100.0% | | *Example* measure | Result | Excel formula | |---|---|---| | Follow-on capital used | 67.0, all reserves | `=SUMPRODUCT(B2:B6,D2:D6)` with follow-on per company in column D | | Gross multiple on invested capital | 3.94x | `=500/127` | | Gross multiple on commitments | 3.33x | `=500/150` | | Distributable proceeds (10 recycled earlier) | 490.0 | `=500-10` | | Carry, 20% of profit over commitments | 68.0 | `=20%*(490-150)` | | Net to LPs and net TVPI | 422.0 and 2.81x | `=490-68` and `=422/150` | | Gross multiple on commitments without the fund returner | 1.47x | `=(500-280)/150` | Half the companies return nothing and the fund still returns 2.81x net, because one company returns 1.87 times the fund (`=280/150`). Without that company, distributable proceeds would be USD 210.0m and LPs would receive about 1.32x net after carry (`=(210-20%*(210-150))/150`), a weak result for a venture fund. Because the fund returner also received USD 12.0m of follow-on, its exit ownership was at least the 8.71% pro rata level, so its exit value was at most about USD 3.2bn (`=280/8.713%`). **Step 4: how many companies? A simulation.** Each company's multiple on invested capital is drawn independently: zero with probability 50%, otherwise a Pareto multiple with minimum 1.0x and tail index 1.15, capped at 100x. The mean multiple per company is about 2.16x. For each portfolio size $N$ the fund invests the same total capital equally, and 100,000 portfolios were simulated in Python (seed 20261028). One draw in Excel: `=IF(RAND()<0.5,0,MIN(100,(1-RAND())^(-1/1.15)))`. | *Example* number of companies $N$ | Median gross multiple | P(at least 1.0x) | P(at least 3.0x) | 10th percentile | 90th percentile | |---|---|---|---|---|---| | 5 | 1.21x | 59.1% | 16.5% | 0.33x | 4.36x | | 10 | 1.42x | 70.3% | 17.6% | 0.60x | 4.41x | | 20 | 1.62x | 82.2% | 18.7% | 0.84x | 4.36x | | 30 | 1.74x | 88.5% | 19.3% | 0.97x | 4.22x | | 50 | 1.87x | 95.0% | 19.8% | 1.13x | 3.63x | | 100 | 2.03x | 99.3% | 12.9% | 1.35x | 3.16x | The median climbs towards the mean and the chance of losing money falls steadily as $N$ grows. The chance of a 3x fund rises a little up to about 50 companies and then falls: with 100 equal positions, even a 100x outcome adds only 1.0x to the fund. Concentrated funds have more spread in both directions. These numbers depend entirely on the assumed distribution and on independence, which overstates diversification (see assumption 2). ```vega-lite { "$schema": "https://vega.github.io/schema/vega-lite/v5.json", "description": "Simulated gross fund multiple by number of companies: median, 10th and 90th percentile (fictional distribution)", "width": 420, "height": 240, "data": {"values": [ {"n": 5, "stat": "Median", "multiple": 1.21}, {"n": 10, "stat": "Median", "multiple": 1.42}, {"n": 20, "stat": "Median", "multiple": 1.62}, {"n": 30, "stat": "Median", "multiple": 1.74}, {"n": 50, "stat": "Median", "multiple": 1.87}, {"n": 100, "stat": "Median", "multiple": 2.03}, {"n": 5, "stat": "10th percentile", "multiple": 0.33}, {"n": 10, "stat": "10th percentile", "multiple": 0.6}, {"n": 20, "stat": "10th percentile", "multiple": 0.84}, {"n": 30, "stat": "10th percentile", "multiple": 0.97}, {"n": 50, "stat": "10th percentile", "multiple": 1.13}, {"n": 100, "stat": "10th percentile", "multiple": 1.35}, {"n": 5, "stat": "90th percentile", "multiple": 4.36}, {"n": 10, "stat": "90th percentile", "multiple": 4.41}, {"n": 20, "stat": "90th percentile", "multiple": 4.36}, {"n": 30, "stat": "90th percentile", "multiple": 4.22}, {"n": 50, "stat": "90th percentile", "multiple": 3.63}, {"n": 100, "stat": "90th percentile", "multiple": 3.16} ]}, "mark": {"type": "line", "point": true}, "encoding": { "x": {"field": "n", "type": "quantitative", "title": "Number of companies", "scale": {"type": "log"}}, "y": {"field": "multiple", "type": "quantitative", "title": "Gross fund multiple (x)"}, "color": {"field": "stat", "type": "nominal", "title": "Statistic"} } } ``` **Conclusion.** Fund I's plan is internally consistent: USD 127m investable, 30 companies at 12.5% entry ownership, reserves of 1.12 per initial dollar, and a fund-returner exit of about USD 1.7bn when the fund takes its Series A pro rata. The plan depends on finding at least one company that reaches that scale and on having the reserves to keep ownership in it. ## Worked example B (half solved): follow-on or a new company **Situation (fictional).** Fund I has USD 3m of unallocated reserves. Option 1: follow on in portfolio company K's Series B at a USD 120m post-money; one more round will dilute by 15%; the partners estimate a 30% chance of a USD 900m exit, and for simplicity every other outcome returns nothing. Option 2: a new seed cheque of USD 3m at a USD 15m post-money; three later rounds dilute by 20%, 18% and 15%; the chance of the same USD 900m exit is 4%. | *Example* item | Option 1: follow-on in K | Option 2: new seed company | |---|---|---| | Ownership bought | $3 / 120 = 2.50\%$ | [ ] | | Exit ownership | $2.50\% \times 0.85 =$ [ ] | $20\% \times 0.80 \times 0.82 \times 0.85 = 11.15\%$ | | Proceeds if the USD 900m exit happens | [ ] | $900 \times 11.15\% = 100.37$ | | Expected proceeds | $30\% \times 900 \times 2.125\% = 5.74$ | [ ] | | Expected multiple | [ ] | 1.34x | | Excel for the expected multiple | `=30%*900*(3/120)*(1-15%)/3` | [ ] | Questions to answer: 1. On these numbers, which option has the higher expected multiple? [ ] 2. Option 2's success case returns about two-thirds of the fund (`=100.37/150`). Option 1's returns how much? Why might a partner still prefer Option 2? [ ] 3. Name two facts about company K that the partners know and the seed founders' data cannot show, and how each would change the decision. [ ] ## Exercise C (unsolved): design a USD 50m seed fund **Situation (fictional).** A first-time manager plans a USD 50m seed fund. Terms: management fee 2.5% a year on commitments in years 1 to 4, then 1.5% a year in years 5 to 10; expenses USD 1.0m; no recycling. The manager wants 60% of investable capital in initial cheques of USD 1.0m at a USD 10m post-money, and the rest in reserves. Later rounds dilute by 20%, 18% and 15%. 1. Compute lifetime fees and investable capital. 2. How many initial cheques can the fund write, and how much is left for reserves? 3. Compute entry ownership and exit ownership with no follow-on. 4. What exit value does one company need to return the fund? 5. Is this exit value realistic for a seed company? What would you change: cheque size, number of companies, reserve ratio or fund size? Give one change and its cost. ## Portfolio construction process The process runs from the fund's terms to a capital budget, then to each investment and each follow-on decision, with a deployment review that feeds back into the plan. ```mermaid flowchart TD A["Fund terms: commitments, fees, expenses, recycling"] --> B["Investable capital"] B --> C["Strategy: stage, sector, lead or follow"] C --> D["Budget: number of companies, initial cheque, reserves"] D --> E["Entry ownership target and fund-returner exit value"] E --> F["New investment: passes the fund-returner test?"] F -->|No| G["Pass, or change cheque size"] F -->|Yes| H["Invest and earmark reserves"] H --> I{"Company raises a new round"} I --> J{"Follow-on beats a new cheque on expected return?"} J -->|Yes| K["Use pro rata or more"] J -->|No| L["Let ownership dilute"] K --> M["Quarterly deployment review against plan"] L --> M M --> D ``` ## Connections to other cards | Card or template | Connection | |---|---| | mba/mba-venture-finance-cap-table-card | Pre- and post-money, dilution, pro rata and preferences for one company | | mba/mba-vc-method-card | Pricing one round from a target exit value and a target multiple | | mba/mba-term-sheet-card | Pro rata rights, preferences and other terms that change proceeds | | mba/mba-venture-capital-guide | The elective roadmap and mini-case | | mba/mba-pe-fund-economics-card | Fees, carry, waterfalls, TVPI, DPI and PME for any closed-end fund | | mba/mba-portfolio-theory-card | Why diversification in public markets works on variance, unlike venture outcomes | | mba/mba-options-real-options-card, mba/mba-decision-trees-card | Staged financing as a sequence of options | | mba/mba-innovation-portfolio-card | The same portfolio logic for corporate innovation bets | | finance/lp-quarterly-report, finance/investment-committee-memo | Reporting deployment and presenting a follow-on decision | ## Common mistakes and misconceptions 1. **Sizing cheques on commitments.** Fees and expenses can take 15% or more of a fund; plan on investable capital. 2. **Ignoring dilution in the fund-returner test.** Entry ownership is not exit ownership; three rounds can halve it. 3. **Treating reserves as optional.** A fund that cannot follow on loses ownership in exactly the companies that matter. 4. **Following on by loyalty.** Each follow-on is a new investment at a new price; compare it with the best new use of the money. 5. **Using average outcomes.** With power-law returns the mean is driven by rare outliers; plan with the distribution, not the average. 6. **Assuming independence.** Companies in one vintage share the same market; real fund outcomes are more spread out than independent simulations show. 7. **Believing more companies is always safer.** More companies reduce the chance of loss but can lower the chance of a very high multiple, because each outlier is a smaller share of the fund. 8. **Ignoring liquidation preferences in modest exits.** Ownership times exit value overstates proceeds for common holders and can understate them for preferred holders. 9. **Reporting a high TVPI early as success.** Early TVPI is mostly unrealised marks; watch DPI. 10. **Forgetting time.** A 3x fund over twelve years is a much lower IRR than a 3x fund over seven. ## Self-test questions 1. A USD 100m fund charges 2% a year on commitments for ten years and has USD 1m of expenses, with no recycling. What is its investable capital? 2. A USD 200m fund expects 8% exit ownership in its best companies. What exit value returns the fund? 3. A fund buys 15% at seed and does not follow on through three rounds that each dilute by 20%. What is its exit ownership? 4. Define the reserve ratio and say why seed funds often plan a ratio near or above one. 5. Why does the median simulated fund multiple rise with the number of companies while the chance of a 3x fund eventually falls? 6. Give two reasons why an independent simulation overstates the benefit of diversification. 7. In Worked example A, what share of proceeds came from the single best company, and what would the gross multiple on commitments be without it? 8. What is recycling, and why does it raise investable capital but not the LPs' paid-in capital? 9. A follow-on at a higher valuation has a higher chance of success but a smaller ownership. What two numbers must you compare? 10. Interleaving: which card answers each question? (a) The price of one Series A round from a target exit multiple. (b) How carry and fees reduce the LP's multiple. (c) Whether to diversify a listed equity portfolio across 30 stocks. ## My notes and next steps | Item | My entry | |---|---| | Confidence with the capital budget and dilution chain (1 = lost, 5 = could teach it) | [ ] | | Confidence with the fund-returner test and reserve decisions | [ ] | | A fund strategy or case I will model with this card | [ ] | | Mistakes logged in mba/mba-error-log | [Date and short description] | | Next review date (spacing: +2 days, +1 week, +1 month) | YYYY-MM-DD | | Next card to study | [mba/mba-vc-method-card / mba/mba-term-sheet-card] | ## Sources and further reading Primary works: - Sahlman, W. A. (1990). The structure and governance of venture-capital organizations. *Journal of Financial Economics*, 27(2), 473-521. - Gompers, P., and Lerner, J. (1999). An analysis of compensation in the U.S. venture capital partnership. *Journal of Financial Economics*, 51(1), 3-44. - Cochrane, J. H. (2005). The risk and return of venture capital. *Journal of Financial Economics*, 75(1), 3-52. - Kaplan, S. N., and Schoar, A. (2005). Private equity performance: returns, persistence, and capital flows. *The Journal of Finance*, 60(4), 1791-1823. - Metrick, A., and Yasuda, A. (2010). The economics of private equity funds. *The Review of Financial Studies*, 23(6), 2303-2341. - Korteweg, A., and Sorensen, M. (2010). Risk and return characteristics of venture capital-backed entrepreneurial companies. *The Review of Financial Studies*, 23(10), 3738-3772. - Kerr, W. R., Nanda, R., and Rhodes-Kropf, M. (2014). Entrepreneurship as experimentation. *Journal of Economic Perspectives*, 28(3), 25-48. - Gompers, P. A., Gornall, W., Kaplan, S. N., and Strebulaev, I. A. (2020). How do venture capitalists make decisions? *Journal of Financial Economics*, 135(1), 169-190. Textbooks (further reading, by name only): Metrick and Yasuda, *Venture Capital and the Finance of Innovation*; Gompers and Lerner, *The Venture Capital Cycle*; Feld and Mendelson, *Venture Deals*. Open resource: the ILPA Reporting and Performance Templates (2025, free on ilpa.org) show the fields an LP report on deployment and performance uses; see mba/mba-pe-fund-economics-card for the dated facts. ## Answer key **Worked example B.** Option 1: exit ownership 2.125% (`=3/120*(1-15%)`); proceeds in the success case 19.13 (`=900*2.125%`); expected proceeds 5.74; expected multiple 1.91x. Option 2: ownership bought 20.0% (`=3/15`); expected proceeds $4\% \times 100.37 = 4.01$; Excel `=4%*900*(3/15)*(1-20%)*(1-18%)*(1-15%)/3`. (1) Option 1, 1.91x against 1.34x. (2) Option 1's success case returns about 13% of the fund (`=19.13/150`). A partner might still prefer Option 2 because it adds a new chance of a fund-returning outcome, and the fund's result depends on outliers; but on expected value the follow-on wins here. (3) For example: K's actual revenue growth and retention (raising or lowering the 30%), and the quality of the Series B lead and its terms (a strong lead raises the chance of later rounds; heavy preferences lower proceeds in modest exits). **Exercise C.** (1) Fees $50 \times 2.5\% \times 4 + 50 \times 1.5\% \times 6 = 5.0 + 4.5 = 9.5$; investable $50 - 9.5 - 1.0 = 39.5$. (2) Initial pool $60\% \times 39.5 = 23.7$, so 23 cheques of USD 1.0m (USD 0.7m unused, or round up to 24 by trimming reserves), reserves USD 15.8m. (3) Entry 10.0% (`=1/10`); exit $10\% \times 0.80 \times 0.82 \times 0.85 = 5.58\%$. (4) $50 / 5.576\% = 896.7$, so about a USD 0.9bn exit returns the fund. (5) A USD 0.9bn outcome is rare but within reach for top seed companies. Options: raise entry ownership with larger cheques (fewer companies, more variance), or raise reserves to keep pro rata in Series A (fewer initial cheques). Each trades the number of chances for the size of each win. **Self-test.** 1. $100 - 2\% \times 10 \times 100 - 1 = 79$, so USD 79m. 2. $200 / 8\% = 2{,}500$, a USD 2.5bn exit. 3. $15\% \times 0.8^3 = 7.68\%$. 4. Reserves divided by initial cheques. Seed companies raise several later rounds, and keeping ownership in the winners requires at least as much capital later as at entry. 5. The average of more draws is closer to the mean (law of large numbers), so the median rises towards about 2.16x; but with many small positions a single outlier cannot lift the fund far above the mean, so the chance of 3x falls. 6. Outcomes in one vintage are correlated (funding markets and exit windows), and the GP's selection and support skills affect all companies in the same way. 7. 56.0%; 1.47x gross on commitments. 8. Reinvesting early proceeds instead of distributing them. LPs pay in only their commitments; the recycled money is proceeds, so it raises capital at work without new calls, and it is not distributed. 9. The probability-weighted exit proceeds (probability times exit value times exit ownership) per dollar for the follow-on, against the same for the best alternative use. 10. (a) mba/mba-vc-method-card; (b) mba/mba-pe-fund-economics-card; (c) mba/mba-portfolio-theory-card. ## Revision history | Version | Date | Author | Change summary | |---|---|---|---| | 0.1 | YYYY-MM-DD | [Your name] | First pass through the card | | 0.2 | YYYY-MM-DD | [Your name] | *Example:* Replaced Fund I with a real fund strategy from a case and re-ran the scenario | ## Standard and licence note Based on standard venture capital practice and the primary works listed above. The text, examples, numbers, simulation and questions are original; no textbook, case or firm material is copied or paraphrased, and Fund I, company K and the seed fund are fictional. The template is independent and not affiliated with or endorsed by any venture firm, business school or publisher. Fund terms are set by each limited partnership agreement; check your own fund documents before you rely on any figure. Template licence: MIT.