A VC fund invests in 20 companies. Twelve are total write-offs. Five return 1-3x. Three return 10x or more. The fund can still earn a positive return. Assume equal-sized checks. Even at the bottom of each band, the 20 units invested return 35 units, a 1.75x gross multiple. That math defines everything about venture capital, and the exam expects you to know why.
Venture capital is a subset of private equity focused on early-stage companies with unproven business models and high growth potential. The key distinction from buyouts: VC targets companies before they generate stable cash flows. Buyouts target mature businesses. VC uses almost no leverage. Buyouts rely on it.
VC funds are typically organized as limited partnerships. The general partner (GP) selects and manages the investments. The limited partners (LPs) commit capital upfront but fund it over time through capital calls. A fund typically has a 10-year life.
KEY: The J-curve describes the typical VC fund return pattern. Early years show negative returns because management fees are paid out of called capital and failed investments are written down.
Common mistakes
- Confusing participating and non-participating preferred payouts. This is optional enrichment beyond the curriculum's securities coverage. Non-participating means you choose the higher of liquidation preference or conversion value. Participating means you take the preference first, then share in the proceeds left after all preferences are paid.
- Mixing up full ratchet and weighted average anti-dilution (also optional enrichment). Full ratchet resets the conversion price to the exact new round price, regardless of how many shares are issued. If Series A was 3, full ratchet sets the conversion price at $3.
- Forgetting that post-money equals pre-money plus investment. When calculating ownership percentage, divide the investment by post-money, not pre-money. A $10 million investment at a $40 million pre-money gives 20% ownership ($10/$50), not 25% ($10/$40). Dividing by pre-money gives 25%, which overstates ownership.
Bottom line
- VC returns follow a power law: about 65% of early-stage financings return under 1x (partial and total losses), versus about 29% later stage, while a few winners drive the fund.
- Historical VC funds: 15.4% weighted-average IRR but a 7.0% median IRR and 0.81x median KS-PME, so fund selection matters
- Stages run Pre-seed, Seed, Series A, Late-stage/Expansion, but rounds are optional and round sizes are typical ranges, not definitions
- Cash burn runway equals current cash divided by monthly burn; companies raise new capital every 1 to 3 years
Exam shortcut
When you see a payout calculation with preferred stock (optional enrichment), check one thing first: is it participating or non-participating? Participating means pay the applicable preferences first, then calculate participation in the remaining proceeds using the eligible ownership percentages. Non-participating means pick the higher. Applying the wrong rule gives the wrong total. When you see a valuation question, match the method to the stage.
The full lesson (about 9,365 words, 62 min read) adds 2 worked examples, all 8 common mistakes, a self-check, free in the app.
Learning objectives
- intro
- firms and funds
- institutional programs
- subscription lines
- lp gp lifecycle
- publicly traded gps
- exit ipos
- exit spacs
- vc overview
- vc stages
- vc risk returns
- vc return research
- vc valuations
- vc financing
- vc securities
- vc dynamics
- growth equity intro
- growth equity valuation
- growth equity deals
- buyouts overview
- buyout strategies
- buyout characteristics
- lbos
- pipes
- liquid alts
- long-hold buyout funds
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