The Hidden Math of VC: How Investors Actually Calculate Returns. | VC & Startup Jobs.
Product Stickiness Framework, Promise-market fit & Promise-market fit hints at product-market fit.
đ Hey Sahil here! Welcome to this bi-weekly venture curator newsletterâwhere we dive into the world of startups, growth, product building, and venture capital. In todayâs newsletter -
Deep Dive: The Hidden Math of VC: How Investors Actually Calculate Returns.
Quick Dive:
Product Stickiness Framework: Triggers, Constraints, and Rituals.
Promise-market fit is an early signal that product-market fit is possible. Why & How?
How to Sell Your Business Model to VCs?
Major News: General Catalyst going publicâA first for VC, DeepSeek claimed $562K daily revenue. SoftBank is in talks to borrow $16 billion to fund AI & More.
20+ VC & Startups job opportunities.
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Dickie Bush on how to tighten feedback loops.
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đ TODAYâS DEEP DIVE
The Hidden Math of VC: How Investors Actually Calculate Returns
When raising funds, many founders struggle to grasp how investors evaluate opportunities. A common frustration is: "Investors passed on our startup because they didnât think it would deliver strong enough returns."
Previously, we shared a post on how to determine whether your startup is venture-backable, along with a framework for assessing it. This time, letâs dive deeper into the math behind venture capital investingâbecause understanding how investors think about money can provide clarity on why they make certain decisions.
Rob Go, co-founder of Nextview Ventures, wrote an insightful piece on how venture investors calculate returns. He broke down some key concepts that many founders overlook. Iâm sharing a few of his points here, along with some of my own thoughts.
There are plenty of articles online about VC multiples and how theyâre calculated. But Iâve always wondered: Do people truly appreciate how difficult it is to generate these kinds of returns? And are they calculating multiples in a way that reflects reality?
At a basic level, a return multiple is calculated by dividing the amount returned by the amount invested.
If a VC invests $10M in a startup and gets back $100M, thatâs a 10X returnâsimple enough, right?
But things get tricky when multiples are inferred from incomplete data. In most cases, only the fund managers know exactly how much was invested and how much was returned. And when youâre working with incomplete data, multiple assumptions come into play.
Here are a few factors to consider when evaluating or estimating returns:
How to Actually Calculate an Investment Return Multiple
One of the most overlooked aspects of calculating VC returns is dilutionâevery new financing round reduces early investorsâ ownership stake.
Letâs walk through a common scenario:
A seed investor puts in $1M at a $10M post-money valuation in a startupâs first funding round. The company eventually sells for $200M.
At first glance, it might seem like the seed investor made 20X their money ($200M / $10M). But in reality, thatâs rarely how things play out.
Most startups raise more money as they grow, often at higher valuations. Every time this happens, existing shareholders get diluted. Companies also expand their option pool, further reducing investor ownership.
Hereâs what that looks like for our seed investor:
The startup raises another $10M at a $50M post-money valuation.
As part of this round, the company expands its option pool by 10%.
After this financing, the seed investorâs original 10% stake is diluted:
20% dilution from new investors.
10% dilution from the expanded option pool.
The investorâs final stake is now 7% at exit.
So instead of getting a 20X return, their $1M investment turns into $14Mâa 14X return. Still great, but quite different from what the simple math suggested.
Another way to frame this:
At the seed stage, the investor paid $1M for 10%. But after dilution, they effectively paid $1M for 7%, meaning their real entry valuation was $14.3M ($1M / 7%).
And this is in a simplified scenario with just one additional round. In reality, most startups raise multiple rounds, meaning dilution continues at each step, further adjusting investor returns.
Below is a sample outcome table for a few scenarios.
What this shows is that the investorâs multiple dramatically changes depending on how many rounds of financing occur after the initial round and the level of dilution of each round.
You can also think about this in terms of effective post-money because it creates a more visceral reaction. If this company goes on to raise multiple financing rounds such that new investors and future employees end up with an additional 50%, the seed investor mathematically invested at a $20M post-money valuation. Still good, but not what you think of as seed-stage prices.
This is why celebrating big financings isnât always such a great thing. Apart from the screwed-up incentives that can arise from overcapitalized companies, each time a company raises money, all prior investors get diluted, which increases the effective post-money of all the earlier dollars.
Factor in all the dollars an investor puts into a company â not just the initial round.
But one might say that this is precisely why itâs important to invest follow-on capital â it helps you protect your ownership. This is true, sort of, but leads to another misconception about multiples:
One needs to consider all the dollars someone invests into a company at each round, not just the initial round.
The problem with follow-on financings is that they have a similar effect on future dilution. Each time an investor puts money into a follow-on round, she preserves her ownership, but increases her cost basis and effective post money.
Back to our hypothetical company and angel investor that invested $1M at $10M post. Letâs say that the company raises just one more subsequent round of financing which is a $10M at $50M post again. But this time, letâs assume the seed investor decides to âlean inâ and write a $2M check at this stage. So, what happens is:
The investor bought 10% of the seed
The investor also bought another 4% at the Series A
The investor invested $3M total
The investorâs seed dollars got diluted by 30%
So, the final ownership is (10% x 70%) + 4% = 11%. Since the investor increased ownership, they did âsuper-pro-rataâ in a company they thought was a winner. The company then sells for $200M.
Quick: Is this investment a 10X for the seed investor who initially invested at a $10M post-money valuation?
The answer is NO. The investor made 11% x $200M = $22M. They invested $3M to get there. So it was a 7.3X with an effective post-money of $27M. Pretty good, but not a 10X return.
This effect is even greater if the investor puts capital into multiple future financing rounds, even if they just keep doing their pro-rata share of the round. The example above is simplistic, and Iâd argue that 70%+ of $200M exits happen with more future dilution than this.
A Few Takeaways
Why investment multiples can be misleading
Itâs easy to assume that a seed investor putting $1M into a $10M post-money valuation will see a 10X return if the company exits at $200M. But in reality, small changesâlike dilution from follow-on roundsâcan quickly turn a 20X outcome into less than 10X. And thatâs assuming no down rounds or recaps, which make things even trickier.
VCs need bigger exits than most assume
When VCs talk about 10X returns, itâs easy to underestimate the exit size needed to achieve that. Even a 3â5X return often requires a much bigger exit than expected. This creates tensionâfounders may see a $300M exit as life-changing, while investors push for a billion-dollar outcome.
Larger funds can lower returns
Early-stage funds donât deploy much into follow-ons at first. But as funds grow, they allocate more capital to later-stage rounds. This raises their cost basis and post-money valuation, making it harder to achieve high multiplesâeven if they avoid backing total failures.
"Pile into your winners" works in limited cases
This strategy makes sense in two situations: when the winners are multi-billion-dollar companies or when investors double down early before others see the potential. Outside of these cases, the risk of misjudging and raising the cost basis can outweigh the reward.
What top VC firms get right
The best firms do three things:
Focus on backing outliers.
Maintain ownership without overpaying.
Keep fund size reasonable relative to their stakes.
VC math isnât complex, but truly understanding how returns work is crucial for both investors and founders.
While the math may be simple, I think itâs very important for VCs & entrepreneurs, to understand how returns are calculated.
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đ QUICK DIVES
1. Product Stickiness Framework: Triggers, Constraints, and Rituals.
Many founders believe that a great app idea is enough to make it successful. But itâs not. What truly matters is the stickiness of your product.
Start thinking about your product in terms of where triggers, constraints, and user rituals exist within it.
The rise of AI means that more user experiences within the best products will be trigger-based, rather than static. And wide open experiences will be less desirable than opinionated, constrained ones.
I love this framework from Greg Isenberg. Itâs the new strategy for thinking about how to keep users engaged with your product.
Trigger action with prompts
Ignite FOMO with constraints
Keep 'em coming back with rituals
2. Promise-market fit is an early signal that product-market fit is possible. Why & How?
If youâre a regular reader of this newsletter, youâve probably read some of our articles on how to determine whether youâve achieved Product-Market Fit.
If you look at the timeline below, youâll see that companies like Notion, Airtable, and Figma took over three years to hit Product-Market Fit. It takes years to find Product-Market Fit, so whatâs the sign that you should keep going
A good first clue is "Promise market fit"âŚ..
I completely agree with Dani Grant (CEO, Jam). However, how to get a clue on âPromise market fitâ
Promise market fit occurs when potential users express interest in your product's value proposition, even before the product is fully developed or launched. The key indicator can be -
Landing Page Engagement
Users share your landing page, subscribe to updates, or show interest in signing up
Indicates your value proposition resonates with them
Early Sign-Ups and Payments
Users willingly sign up for waitlists or pay for early access
Suggests genuine belief in your product's promise
User Feedback and Iteration
Early user feedback aligns with your product's promise
Iterating based on feedback refines your offering to better meet market needs
Referral Activity
Users refer others to your product
Organic word-of-mouth signals perceived value
Social Media Buzz
Positive mentions, shares, and discussions on social media
Indicates your product has struck a chord with your target audience
Interest from Influencers or Industry Leaders
Key figures express interest or engage with your product
Validates your offering's promise and attracts a broader audience
While following this indicator, donât fall into the trap of fake Product-Market Fit. These early indicators will help you stay on course and achieve true Product-Market Fit.
3. How to Sell Your Business Model to VCs?
When it comes to the business model, itâs not enough to simply describe your pricing. To convince investors, your slide must explain the following:
how you will make money
why that engine will be efficient
how it will turn into a competitive advantage in the long run
And thatâs where things get tricky. Many believe the best course of action is stripping the business model slide to the bones and avoiding burdening it with unnecessary metrics and information. The problems begin when some of those metrics and information you leave out turn out to be pretty darn necessary for selling your model to investors.
So here are the 4 mistakes that I see founders make, and ways to fix them:
1. Mistake #1: Treating Your Business Model as a Pricing Slide
Instead of just listing pricing tiers, explain the overall mechanics of your business model, including primary revenue streams (subscriptions, transaction fees, etc.), and the logic/key drivers behind them.
2. Mistake #2: Having Too Many Revenue Streams
Early-stage companies should focus on a maximum of 3 core revenue streams, with 1-2 being the primary focus. Differentiate between current and future revenue sources.
3. Mistake #3: Not Showing Your Competitive Advantage
Highlight the unique competitive edge or "moat" that makes your business model sustainable and de-risks it for investors (e.g., low costs, high margins, effective land and expand motion, scalability).
4. Mistake #4: Not Discussing Business Model Economics
Illustrate the attractive aspects of your unit economics to support your claims, such as low Customer Acquisition Cost (CAC), high Customer Lifetime Value (LTV), favourable LTV: CAC ratio, short payback cycles, and high-profit margins.
Bonus Tip The Ultimate Business Model Slide Investors love a slide that concisely presents the key business model drivers, the path to $100M+ revenue, and verification against the overall market size.
So, keep your business model slide clean, focus on the primary model and key revenue streams, and include a few crucial unit economics metrics to justify your strategy.
THIS WEEKâS NEWS RECAP
đď¸ Major News In Tech, VC & Startup Funding
General Catalyst, a venture firm managing over $30B in assets, is reportedly considering an IPO, Axios reported. (Read Here)
DeepSeek boasted a theoretical 545% profit margin, estimating $562K in daily revenue from R1 pricing, while GPU leasing costs stood at $87K. (Read Here)
SoftBank CEO Masayoshi Son aims to borrow $16 billion to expand AI investments, with an additional $8 billion possible in early 2026. (Read Here)
Microsoft will shut down Skype on May 5, ending its 23-year run to focus entirely on Teams, with user data and contacts migrating automatically. (Read Here)
Alphabet's Taara project, developed by Google's X research wing, uses light beams to transmit internet signals over long distances, offering an innovative alternative to traditional fibre optics and satellite methods. (Read Here)
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