In today’s interview, we quickly discussed the key metrics by which venture fund managers are measured. I’d like to use this week’s tip to review what these metrics are, who values each and why some can be manipulated while others can’t.
The metrics we will review include: DPI, TVPI, IRR, Follow-on and Bulge Bracket Follow-on. And, in the case of the first three, I will use definitions from Silicon Valley Bank.
- DPI: The ratio of cumulative distributions to limited partners divided by the amount of capital contributed by the limited partners. The nice thing about this metric is that it compares actual dollars distributed to LPs against the dollars that they invested. It is a true cash-on-cash multiple. The drawback is that it’s typically not usable, until later in a fund’s life. It’s rare for a new fund to have exits and cash distributions very early, so the metric doesn’t paint a clear picture early on. From my discussions, it appears that a 3-5x DPI puts you on the big board.
- TVPI: The sum of cumulative distributions to limited partners and the net asset value of their investment, divided by the capital contributed by the limited partners. So this metrics accounts for both cash distributions to LPs and the net asset value of existing investments that have not yet exited. In theory, it sounds great but the problem here is that paper valuations, in venture, are pretty unreliable. Some may go to zero, others to the moon and yet others may languish in the private markets for many years… delaying an exit and cash distribution. It’s also worth mentioning that neither of these first two metrics accounts for the time it takes to return capital, which leads us to our next metric…
- IRR: The annualized effective return rate which can be earned on the contributed (invested) capital, i.e. the yield on the investment. This determines the time-adjusted yearly rate of return. Many great firms are in the 20’s. Many not so great are in the low single digits. On paper, this would seem like the best metric for assessing winners. However, it’s an easy metric to manipulate. GPs can do a number of things to inflate their IRR. Namely, they can borrow money from a bank, at low interest, invest that capital in a startup, then call the capital from the fund much later. This effectively reduces the time between when the capital was invested and when distributions are made. I’ve even heard of cases, with early exits, where the capital isn’t officially invested until after distributions are already made. This causes some firms to show doctored IRRs that are very high, particularly early in a fund’s life.
- Follow-on: This is simply a percentage that represents the number of companies that have received follow-on funding vs. the total number of companies invested in. This metric can be used to assess Series A follow-on ratio, Series B, etc… depending on how mature investments are.
- Bulge Bracket Follow-on: This is a key metric that I hear about more often lately. Great institutional investors don’t care about follow-on alone; they want to see the percentage of follow-on by the best performing A and B investors. If you’re a GP, how many of your investments receive funding from Sequoia, Accel, Bessemer, KPCB, etc. When assessing funds very early in their lifecycle, this can be a helpful signal that shows both quality of investment, relationships with top firms and outcome potential.
In discussions with a wide range of LPs, including HNW, UHNW, family offices, fund of funds, sovereign wealth, foundations, pensions, and endowments… My big takeaway is that there is no silver bullet. Each type of LP and each individual LP looks at different metrics. Trey likely has his own priority and even cited the merits of DPI as it can’t be easily manipulated. Many HNW retail investors also tend to prefer cash-on-cash multiples over IRRs or follow-on. Regardless, each GP must measure them all and be measured by each. Those that optimize for one, at the expense of others, may not be raising a fund 2.
134. The Importance of Storytelling, VC EQ, and the LP-GP Dating Game, Part 2 (James R. ‘Trey’ Hart III)
Today we cover Part 2 of the GP-LP relationship with Trey Hart of Northern Trust. In this segment we address:
- Key mistakes that GPs make
- The key characteristics that successful GP’s share
- The importance of an ownership focus
- What winning really looks like for GPs, in terms of metrics (ie. DPI, TVPI, IRR, cash on cash, bulge bracket follow on, etc)
- Trey’s final thoughts on the GP-LP relationship and who he’d like us to have on the program
133. The Importance of Storytelling, VC EQ, and the LP-GP Dating Game, Part 1 (James R. ‘Trey’ Hart III)
SVP of 50 South Capital at Northern Trust, Trey Hart, joins Nick for a deep dive on the relationship between LPs and GPs. In Part 1, we will address questions including:
- Trey’s path to becoming an LP
- His thoughts on being a GP
- The types of GPs and categories they fall into
- The importance of storytelling
- Herd mentality in the LP community
- If he’ll consider first-time fund managers
- Thoughts on if LPs are looking for GP’s w/ an EDGE
TastyTrade was kind enough to invite Nick on their program, Bootstrapping in America. In this episode the interview audio will be available on the podcast and the video is here on the blog. Hosts Kristi Ross and Tony Batista interview Nick about the Podcast, the investment group and what types of startups he invests in.
- What are your thoughts on the state of the overall venture market?
- Why do you invest at the early stage?
- Is early stage investing about return opportunity and volume of investments?
- How long have you been doing the podcast and what topics are you covering?
- What questions do you focus on for the podcast?
- What’s the demographic of investors in your syndicate?
- You had background in M&A. It seems like you’d be able to apply that to your investing now. What are the most notable experiences or skills you gained while doing M&A
- How many companies are you invested in?
- How do you pick your favorite investments?
- Can you talk about examples of your investments and how that fits with your investment focus?
- Why do you require startups that have a business model with an annuity?
- Are you going back to your experience building and launching a product and investing in similar types of products?
- Can you talk more about why the generalists are going away and what types of VCs are positioned for success?
On this special segment of The Full Ratchet,
the following investors are featured:
Each investor describes a situation where they did
decide to invest, what the key factors were that led
to “Yes” and how that investment has worked out.
Today we cover Part 2 of hardware products that have succeeded where others failed with Ben Einstein of Bolt. In this segment we address:
- You’ve discussed Pebble’s inability to ‘cross the chasm’ and access the early & late majority, while Fitbit was able to. What were the key reasons why Fitbit succeeded where Pebble did not?
- What are your thoughts on using hardware as a Trojan Horse?
- Do you think these lessons are exclusive to hardware startups or do they apply to software as well?
- You’ve been attending CES for 10 years now and seen the evolution of Eureka Park as well as the show at large… what are some of the key observations over that period?
- Any other thoughts or advice you’d give to founders starting a hardware, IoT or connected device startup?
Ben Einstein of Bolt joins Nick to cover Hardware products that have succeeded where others failed, Part 1. We will address questions including:
- To start off, can you talk about your thesis and approach toward investing in hardware?
- What are your thoughts on hardware startups designing for one use case vs. building a platform?
- You’ve cited the example of Google Glass vs. Snap Spectacles. Can you highlight the key difference in the approach for each of these products?
- What two things has Snap done well w/ Spectacles that hardware startups can learn from?
- Another example you highlight, re. broad vs. narrow scope, is Apple Siri vs. Amazon Alexa… what are the key differences you’ve noticed in these two approaches?
- What are the key things that founders should take away from Amazon’s approach
- Design iteration is easy in SaaS, not in Hardware. How do you advise hardware startups w/ regard to iterating and design improvements.
- What’s your opinion of Kickstarter/Indiegogo as a way to validate customer demand?
- Rather than a $1M in sales on a crowdfunding site, what validation would you like to see from hardware founders?
On this special segment of The Full Ratchet,
the following investors are featured:
Jonathon Triest & Brett DeMarrais
Stuart Larkins & Ezra Galston
Each investor highlights a situation where
they decided not to invest, why they passed,
and how it played out.
Welcome back to TFR for another Cram Session. In these special releases, we have aggregated the takeaways and tips from previous episodes. In this installment, we will be recapping the following episodes:
- 73. Virtual Reality Investing, Part 1 (Adam Draper)
- 74. Virtual Reality Investing, Part 2 (Adam Draper)
- 75. No Fun Allowed, Part 1 (Jonathon Triest & Brett DeMarrais)
- 76. No Fun Allowed, Part 2 (Jonathon Triest & Brett DeMarrais)
- 77. Artificial Intelligence Investing, Part 1 (Nathan Benaich)
- 78. Artificial Intelligence Investing, Part 2 (Nathan Benaich)