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Till now you have been reading articles on how the investors (VCs / Angel Investors) evaluate the startups and make the investment decision. But today’s article is on how the LPs (HNIs, Pension Funds or endorsement funds) evaluate the performance of any venture capital fund & make the decision to invest in that.
So grab your coffee and let’s deep dive into it!
There are generally three terms that LPs use to evaluate the performance of a VC fund:
Distribution Paid In Capital (DPI)
Residual Value Paid In Capital (RVPI)
Total Value Paid In Capital (TVPI)
Total Value Paid In Capital (TVPI) = (D+RV) / Paid In Capital(PIC)
Paid in Capital: It is a contributed capital or drawn capital.
Source: Google Images
Let’s take an example and try to understand each term:
Suppose Limited Partners (LP) committed to invest around $5M in a VC fund and General Partners (GP/VC) ask for an amount of $4M for 3 years out of $5M. So here Paid in Capital (PIC) = $4M.
[ Remember: the Paid In Capital is different from the Committed Capital. The Committed capital is the amount of money that an investor agrees to contribute to the investment fund. here Committed capital is $5M and Paid Capital is $4M (previously mentioned). ]
So what’s the Distribution Paid in Capital (DPI) and Residual Value Paid in Capital (RVPI) in this example?
Distribution Paid In Capital (DPI): It is the amount of money that the VC fund has returned to the Limited Partners, which is low in the early year and increases over the period.
Residual Value Paid In Capital (RVPI): It is the amount of money that remains after the distribution or is returned to the Limited Partners.
Ex - Suppose VC Fund has decided to invest in 20 startups and out of that, VC funds have exited from 5 startups and that money is returned to the investors and now the remaining investment is 15 startups. So if the 15 investment value is $150M and cash is around $10M. So the Residual Value of the Fund is $150M + $10M = $160M.
Total Value Paid In Capital (TVPI) = DPI + RVPI
Now, let’s understand all terms with one example of a VC fund
Ex: Fund’s Paid In Capital (PIC) = $70M
Distribution Capital (D) = $80M and Residual Capital (R) = $100M (Hope you are getting the idea of what these terms are from the above explanation)
Calculation:
Distribution Paid In Capital (DPI) = D / PIC = 80 / 70 = 1.1420X
Residual Value Paid In Capital (RVPI) = R / PIC = 100 / 70 = 1.428X
Total Value Paid In Capital (TVPI) = DPI + RVPI = 1.1420 + 1.4280 = 2.57X
Explanation:
DPI = 1.1420X i.e. Fund has returned to LPs all paid-in capital i.e. $70M and received 14.28 above that original amount paid.
RVPI = Still a lot of value of funds left behind, which will return to LPs in the coming time.
TVPI = Total value of fund utilized.
This means the fund is able to generate more return over the original amount i.e. paid-in capital. You can try out this example to calculate in Excel.
That’s it. I hope it will help you to understand how the limited partners evaluate the venture capital fund performance.
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📢 Featured Article: How Much Should You Raise in Your VC Round?
I was reading an article by Marc Suster on fundraising & found this interesting article that might be helpful to founders & investors. So here is the summary of that article:
Navigating a VC meeting can be a daunting task for any founder. It's not just about your elevator pitch, but also about understanding the financial factors that a VC evaluates.
VCs are looking for a clear understanding of your "Cash In, Cash Out, Milestones Achieved" strategy. They want to know how much cash you're raising, if it's a realistic amount, how long will it last, and what progress you'll make during this period.
When it comes to 'Cash In', VCs are looking for reasonableness. Are you raising an appropriate amount of capital relative to your progress, team size, and needs? They're not interested in funding founders who raise too much money in a given round, as it can lead to burning through cash too quickly.
The amount you raise is often a proxy for your valuation. If you're raising $8–10 million, a VC hears “$24–40 million pre-money valuation expectations.” It's important to be realistic about your ask, as asking for an unrealistic amount of money can quickly disqualify you from potential funding.
'Cash Out' is when you're out of money. It's generally expected that you'll be raising 18–24 months of cash in a VC fundraising. VCs often don't want to see a plan that funds longer than 2 years, and seldom do they want to see 3 years.
Lastly, VCs are interested in the milestones you would have achieved by the time you're raising your next round of capital or by the time you're out of money. They want to know what you will have accomplished by the next time you go out to raise and if it will be enough for another VC to show interest.
Understanding these financial factors will make your VC meetings much easier. Remember, VCs want to fund innovations but they are also very cognizant of how much firm risk they can take on given the size of their fund and the number of deals they want to do per fund.
If you are interested in reading this article, feel free to check out here.
📢 Tweet: Is it Better To Target A Small Market or A Large One?
Mike McGuiness shared an awesome tweet on targeting small or large markets - where he shared a video of Peter Thiel talking about the framework of evaluating the markets. Look at this. 👇
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