The math of early stage venture capital
Today I met with an entrepreneur in the travel space that kept reiterating that they wanted to grow organically and without burning money. The “startup” wanted to take it’s a offline business model of booking air tickets, where it earned a respectable profit – online.
Coming from a strong referral I spent a couple of hours understanding what they did. I concluded that while their current business model was perfect for a family run business they didn’t realise that early stage venture capital would demand that they show rapid growth in the value of the company.
So, I explained to them the following math:
- As an early stage venture capitalist I want to build a portfolio of startups that will yield atleast 60% irr.
- So if I put Rs. 100 in 10 startups I have a total portfolio investment of Rs. 1000
- My holding period for an investment is 7 years
- After 7 years the Rs. 1000 investment at 60% irr would turn into Rs. 26,843.50
- I expect 9 out of 10 startups to fail
- Therefore I expect that the return from a single startup will return the Rs 26,843.50
- So, the single investment of Rs. 100 should to return a 122% irr or 268x in 7 years to grow to Rs. 26,843.50!
At the end I explained to them if their business lacked the potential to growing a rapid pace then early stage venture capital was the wrong form of capital to raise. I think something clicked in their mind when I drew out these numbers and they left thanking me.
I just hope I didn’t scare them off venture capitalists, forever!