Venture Capital ROI Expectations
Venture capital ROI expectations can depend on the business in which one is investing. Venture capital investing is risky but expect your money to be doubled.3 min read
Venture capital ROI expectations can depend on the business in which one is investing. While venture capital investing can be a risky proposition, most investors expect to at least double the money that they have invested.
Introduction to Venture Capitalists and Return on Investment
If you're interested in starting or expanding your business, you can get the infusion of cash that you need to achieve these goals by seeking investments from venture capitalists. Before seeking these investments, however, you should be aware that there will be a cost involved. Venture capitalists don't give their money away for nothing, and will expect a strong return on investment.
To receive an investment from a venture capitalist, you will need to promise them a strong return, and in most cases, you will also need to provide them with an ownership stake in your company.
Return on Investment Ranges
The risk of venture capital investing is that it can be hard to tell at the outset whether an investment will actually pay off. While some ventures can result in returns that are multiple times the original investment, many investments will end in a negative return. The National Bureau of Economic Research has stated that a 25 percent return on a venture capital investment is the average. Most venture capitalists or venture capital returns will expect to at least receive this 25 percent return on investment. Depending on your business's potential for growth, a venture capital investor may expect a much greater return.
The purpose of making venture capital investments is the ability to receive a tremendous return from these investment, and it's common for investors to desire that their initial investment be at least doubled. Fortunately, investors do not expect this return immediately. Experienced venture capitalists usually consider a successful investment one that doubles in a period of 10 years.
You should consider several factors when calculating the return on investment you will need to promise:
- Your company's valuation.
- How much money the venture capitalist is providing.
- The risk potential from investing in your business.
Negotiating Returns on Investment
Venture capital firms will frequently have a large investment portfolio. This means that your company will be one of many receiving investments from the firms. Depending on your business, this can help you more effectively negotiate your promised returns.
If your company is low-risk, for example, you may be able to promise a lower return than what a high-risk company would need to offer in order to receive an investment. Venture capital firms prefer their portfolio to contain a mixture of low-risk and high-risk investments, known as diversification.
If you are struggling to meet your payroll and don't have the money necessary to grow your business, a venture capital firm will usually consider you a high-risk investment. When a venture capital firm determines there is higher risk involved in investing in your company, you should prepare to offer a higher return.
Company Valuation and Venture Capital Math
The most common method that venture capital firms use to determine their expected return on investment is by valuating your company. Fortunately, you are not required to accept the valuation determined by the venture capital firm.
In general, after a venture capital firm provides you a valuation, you should counter by asking for a valuation that is 25 percent higher. Requesting this higher valuation is common when negotiating with venture capital firms. Negotiating a higher evaluation will make your company more appealing to the investor, although it will also allow them to ask for a higher return on investment.
In most cases, only a small portion of a venture capital firm's portfolio will result in a return on investment. For example, if a firm invests in 10 companies, it's possible that only two of those investments will result in a gain, meaning the other eight investments ended in a negative return.
Because it's so common for these investments to fail, venture capitalists are very careful about which companies they provide money. If you want to receive a venture capital investment, you will need to demonstrate that investing in your company is likely to result in a big return on investment, particularly if your company is involved in a risky field.
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