Investor IRR on Paper to Raise Another Fund

Recently I was meeting with a venture investor talking about the market and opportunities at the Atlanta Tech Village. He had just joined a new partnership, so, naturally, I asked what happened at his previous firm. He said the firm had made the targeted number of investments, but didn’t have the required internal rate of return (IRR) to raise another fund, and was desperately trying to make the existing investments more successful.

Here are a few thoughts on investor IRR on paper to raise another fund:

  • Current boom times, where hot startups raise more money at ever higher valuations, makes the paper returns for the earlier investors excellent, even though some of those startups won’t be able to grow into their valuation
  • Investor returns, outside of exits or selling a piece of the investment, are measured via mark to market, such that the main way to get a new market price is by raising another round of funding, hence the VC desire to raise more money at a higher valuation
  • Some funds, that had poor overall returns, but good returns for a select number of the partners, market their next fund based on the returns on the partners that did well, and not the overall fund numbers
  • Most funds don’t achieve their stated goal of returning three times the money in seven years, which is 17% IRR (see Demystifying Venture Capital Economics), and thus can’t raise another fund

When talking with investors, it’s important to understand the firm dynamics, especially where they are in their fund lifecycle. Also, note that returns on paper, not necessarily exits, are needed to raise another fund.

What else? What are some other thoughts on investor IRR on paper to raise another fund?

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