A VC fund invests in 20 companies. Twelve are total write-offs. Five return 1-3x. Three return 10x or more. The fund still posts a top-quartile return. 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 structured as limited partnerships with a 10-year life. The GP manages investments and earns management fees (typically 2%) plus carried interest (typically 20% above a hurdle rate). LPs commit capital upfront but fund it over time through capital calls.
HIGH-FREQUENCY: The J-curve describes the typical VC fund return pattern. Early years show negative returns from management fees, capital calls, and write-downs of failed investments. Later years show positive returns as successful exits materialize.
Common mistakes
- Confusing participating and non-participating preferred payouts. Non-participating means you choose the higher of liquidation preference or conversion value. Participating means you get both. If the exam asks for the total payout under participating preferred and you only report the conversion value ($10 million in Example 2), you missed $8 million.
- Mixing up full ratchet and weighted average anti-dilution. 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). The 25% figure is the trap.
Bottom line
- VC returns follow a power law: a few winners drive the fund and a 60% write-off rate is normal
- Four stages run Pre-seed, Seed, Series A, Late-stage/Expansion; early-stage spans the first three
- Cash burn runway equals current cash divided by monthly burn; companies raise new capital every 1 to 3 years
- Three risk premiums (business, liquidity, idiosyncratic) justify a 400 to 800 bp spread over public equity
Exam shortcut
When you see a payout calculation with preferred stock, check one thing first: is it participating or non-participating? Participating means add the preference and the conversion share. Non-participating means pick the higher. The trap is always the one you would get by applying the wrong rule. When you see a valuation question, match the method to the stage. Pre-revenue with a big industry, use TAM.
The full lesson (about 5,673 words, 38 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 term performance
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