What is Venture Capital?
Venture capital is a form of private equity financing that supports startups and emerging companies with high growth potential. These companies are often in the early stages of development, meaning that venture capital investments carry more risk compared to more traditional investments. In exchange for taking on this risk, VC investors receive equity in the company, hoping to benefit from substantial returns if the startup succeeds.
According to Meketa Investment Group, VC-backed companies have historically outperformed public equities, but returns are highly skewed toward a small number of successful investments.1
As more accredited investors gain access to venture capital through funds like Dickson & Main, it’s important to understand the metrics and terms that define the venture capital landscape.
Key Venture Capital Terms & Metrics
Valuation
Valuation plays a crucial role in venture capital investing as it determines how much ownership an investor receives in exchange for their investment.
The two key types of valuation are:
- Pre-Money Valuation: This refers to the valuation of a company before receiving new investment. It helps determine the price per share and ultimately influences the percentage of equity investors will own.
- Post-Money Valuation: This is the valuation of the company after the investment is made. It reflects the added value from the new funds and helps calculate ownership dilution.
Valuation metrics fluctuate depending on market conditions and investor sentiment. According to PitchBook, median pre-money valuations for early-stage startups have increased significantly over the past decade, particularly in sectors like artificial intelligence (AI).
- Artificial Intelligence (AI): In the first quarter of 2024, early-stage AI companies had a median valuation exceeding $70 million, significantly higher than valuations in other verticals. 2
Internal Rate of Return (IRR)
IRR is a commonly used metric in private market investing, representing the annualized return an investor can expect to earn, assuming the investment’s cash flows are reinvested at the same rate.
Cambridge Associates data shows that top-performing VC funds generate annual IRRs exceeding 20%, but many funds underperform, making fund selection critical.3
Multiple on Invested Capital (MOIC)
MOIC is a straightforward way to measure return potential without factoring in the time value of money.
- Formula: MOIC = Total Value of Investment / Capital Invested
Example:- If you invest $1 million in a company and it exits at $5 million, the MOIC is 5x.
- A MOIC of 3x–5x is considered strong for venture capital funds.4
TVPI (Total Value to Paid-In Capital)
TVPI is an important metric for assessing a fund’s overall performance. It calculates the ratio of realized and unrealized value relative to total invested capital:
- Formula: TVPI = (Distributions + Residual Value) / Paid-In Capital
According to PitchBook, the median TVPI for early-stage venture funds is around 1.6x–2.2x at the 10-year mark.5
DPI (Distributions to Paid-In Capital)
DPI measures the cash returns investors have received relative to their original investment.
- Formula: DPI = Cumulative Distributions / Paid-In Capital
A DPI of 1.0x means investors have been fully repaid their initial investment, while higher DPI values indicate profitability.
Cambridge Associates reports that top-quartile VC funds typically achieve DPI greater than 2.0x over a 10-year horizon.6
J-Curve
The J-Curve describes the typical pattern of returns in venture capital:
- Early years (negative returns): High upfront costs (e.g., management fees, failed investments).
- Later years (positive returns): Portfolio companies mature and successful exits drive performance upward.
According to Cambridge Associates, VC funds typically experience negative IRRs for the first 3–5 years before turning positive in later stages.7
Burn Rate and Runway
Burn rate measures the rate at which a startup spends capital before becoming profitable.
Runway estimates how long a startup can operate before needing more funding:
Runway = Cash on Hand / Monthly Burn Rate
A high burn rate with short runway signals financial instability, while a sustainable burn rate indicates strong financial health.
Exit Strategies in Venture Capital
An exit strategy refers to the method through which investors realize returns on their investments. Common VC exit strategies include:
- Initial Public Offering (IPO): A company goes public and sells shares to investors.
- Acquisition: A larger company buys the startup, providing liquidity to investors.
- Secondary Sale: Investors sell shares to another investor or private buyer.
According to PitchBook, the median time for a successful venture-backed company to exit via IPO or acquisition is 8–10 years.8
Conclusion
Venture capital investing offers accredited investors the opportunity to participate in the growth of high-potential startups.
By understanding the following, investors can make informed decisions about which venture capital opportunities to pursue.
- Key terms like valuation and equity ownership
- Performance metrics like IRR, MOIC, and DPI
- Risk factors like the J-Curve and burn rate
- Exit strategies like IPOs and acquisitions
At Dickson & Main, we provide accredited investors with curated opportunities to invest in emerging companies poised for success. By mastering these fundamental terms and metrics, you’ll be better equipped to navigate the exciting world of venture capital investing.
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