Venture Fund Portfolio Construction | Journal | Kauffman Fellows

Funds taking a more concentrated approach and investing in fewer companies most likely are assuming that one of their investments has an extremely large outcome while the rest either go to zero or whose exits are much more modest. This is called the power law dynamic and historically, this can be seen happening often in venture capital. Funds takin... See more

Finally, another common approach is to back into the required fund value to guarantee a Net LP return multiple (i.e. net of fees and carry). For e.g. for a $100M fund to return 3x net to its LPs given the standard 2 and 20 model and $850K in total fund expenses, the total net return for the fund would have to be $370M after taking into account the ... See more

Of course most funds hope that not all but one company they invest in has an exit, so the GPs must then make some assumptions around the percentage of companies that go to zero, return 1x capital, return a modest 3x capital, return a healthy 25x capital and return more than 100x capital. Making assumptions around graduation rates can help GPs bette... See more

Some funds perform “return the fund” analysis before making an individual investment. This analysis essentially looks to understand what value a given company would have to exit at to both return the fund as well as hit the targeted net return given assumed dilution over time.

Graduation Rate Assumptions: Individual company dilution needs to be factored into fund performance. One way to do this is to make some assumptions around the percentage of total companies raising subsequent financing rounds, as well as assumptions on the size and pre-money valuations of those rounds. Some funds may assume that of all the seed inv

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Required Return Fund Capital to Targeted Net Return: Going off the example above, if a fund is targeting a 3x net return, meaning they wish to pay to their investors $3 for every $1 invested, the required fund return to hit 3x is actually higher than $300M given fees and carry. It is important to understand the total required return needed to hit

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Fee and Expense Recycling: Fee recycling is reinvesting the fund expenses and management fees (usually as follow-on investments) as distributions occur. For a $100M fund with a 2% yearly management fee, there will be $20M in total management fees taken over the life of the fund. Many funds look to reinvest the full fund into companies and will inv

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Follow-On Reserves: The percentage of the fund that will be reserved to make follow-on investments into the fund’s best-performing companies. Some funds have a two-for-one follow on ratio meaning that for every dollar they first invest into a company, two more dollars are reserved for follow-on, while other funds aim to take a larger ownership per

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