Case 088Fund economics and LP mathsHard

Build the model for Lakshvik Seed Fund I: Rs 400 crore, 2% fees for ten years, Rs 3 crore initial cheques for 12%, half of investable capital reserved for follow-ons, 40% dilution on initial stakes. How many companies does it back, and what total exit value must the portfolio produce for 3x net after 20% carry?

The situation

Lakshvik Seed Fund I is raising Rs 400 crore from limited partners (LPs). The manager charges a 2% management fee on committed capital every year for ten years and takes 20% carried interest on profits once LPs have their capital back. For this case, ignore any hurdle rate and assume fees are not recycled.

The strategy: write Rs 3 crore first cheques for 12% of seed-stage companies, and hold back half of the capital left after fees as reserves to follow on in the companies that do well. Later rounds are expected to dilute each initial 12% stake by 40% before exit. An LP asks what the portfolio has to achieve for the fund to return 3x net of fees and carry.

Your task

How many companies does the fund back, and what combined exit value must those companies reach for LPs to get 3x net?

Quick check

How much must the fund distribute in total for LPs to receive 3x net?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Lakshvik backs 53 companies and needs Rs 1,400 crore of distributions, which means roughly Rs 14,972 crore of combined exit value. Fees take Rs 80 crore; half of the Rs 320 crore left buys 53 stakes at Rs 3 crore. Carry adds Rs 200 crore to the Rs 1,200 crore LPs need. If reserves return 2x, the initial stakes must deliver Rs 1,078 crore at 7.2% ownership each.

Step 1Where does the Rs 400 crore actually go?

If you pool money with friends to buy a share of several restaurants, and pay a manager to pick them, you know the manager's salary comes out of the pot before any restaurant is bought. A fund is the same: 2% a year for ten years is Rs 80 crore of fees, which leaves Rs 320 crore to invest, and half of that is held back for follow-ons. Rs 160 crore for first cheques at Rs 3 crore each is 53 companies with Rs 1 crore left over, which joins the reserves at Rs 161 crore.

Where Lakshvik's Rs 400 crore goesFeesRs 80 crore2% x 10 yearsInitial chequesRs 159 crore53 x Rs 3 crReservesRs 161 crorefollow-ons in winnersInvestable capital Rs 320 crore, half held back as reservesEach Rs 3 crore cheque buys 12% at a Rs 25 crore post-money; 40% later dilution leaves 7.2% at exit.A single company returns the whole fund only with an exit of Rs 5,556 crore.
Of Lakshvik's Rs 400 crore, Rs 80 crore goes to fees, Rs 159 crore buys 53 initial stakes and Rs 161 crore is reserved, so only about two-fifths of the fund buys the first-cheque ownership that drives most of the return.
Step 2How much must the fund distribute for 3x net?

3x net on Rs 400 crore is Rs 1,200 crore to LPs. Carry is 20% of the profit above the Rs 400 crore LPs get back first. If the fund distributes D, LPs keep D minus 20% of (D minus 400), and setting that to 1,200 gives D of Rs 1,400 crore, with Rs 200 crore of carry. Against the Rs 320 crore actually invested, that is a gross multiple of 4.38x. Fees and carry together open a gap of more than a full turn between what the portfolio earns and what LPs receive.

The relationship
D−0.20 (D−400)=1,200  ⇒  0.8D=1,120  ⇒  D=1,400D - 0.20\,(D - 400) = 1{,}200 \;\Rightarrow\; 0.8D = 1{,}120 \;\Rightarrow\; D = 1,400
Dtotal distributions from the fund, Rs crore
0.20 (D - 400)carry: 20% of profit above committed capital
1,2003x net to LPs on Rs 400 crore
What it says in wordsGross distributions must cover LPs' 3x plus the manager's fifth of the profit.
Step 3What exit value does that require from the companies?

Reserves go into later rounds at higher prices, so they usually earn a lower multiple than first cheques. Assume reserves return 2x, Rs 322 crore; the initial stakes must then produce Rs 1,078 crore. Each initial 12% is diluted by 40% to 7.2% at exit, so the companies must reach about Rs 1,078 crore divided by 7.2%, Rs 14,972 crore of combined exit value. Spread evenly that is about Rs 282 crore per company, but seed returns are never even.

From 3x net back to the exit value the portfolio must produceLPs receiveRs 1,200 cr3x net of Rs 400 crFund distributesRs 1,400 cr+ Rs 200 cr carryFrom initial stakesRs 1,078 crafter Rs 322 cr from reservesExit value neededRs 14,972 crat 7.2% ownershipOne way the portfolio could produce it, Rs crore of exit value7,500one Rs 7,500 cr outcome4,500three at Rs 1,500 cr2,972the other 49Half the required value can come from one company; the average company must exit at about Rs 282 crore.
Working back from Rs 1,200 crore to LPs, the fund must distribute Rs 1,400 crore, the initial stakes must supply Rs 1,078 crore after reserves, and at 7.2% ownership that needs about Rs 14,972 crore of exit value, half of which could come from a single company.
StepRs crore
Committed capital400
Fees, 2% for 10 years80
Initial cheques, 53 x Rs 3 crore159
Reserves161
LPs' 3x net1,200
Carry, 20% of profit200
Gross distributions needed1,400
From reserves at 2x322
From initial stakes1,078
Combined exit value at 7.2% ownership14,972
Every line of the model reconciles: fees, cheques and reserves sum to Rs 400 crore, and Rs 322 crore from reserves plus Rs 1,078 crore from initial stakes is the Rs 1,400 crore the fund must distribute.
Step 4What does the model tell an LP about the strategy?

The number that matters is the fund returner. A single company returns the whole Rs 400 crore fund only if it exits at Rs 5,556 crore, because the fund owns 7.2% of it by then. For 3x net, Lakshvik realistically needs one outcome around Rs 7,500 crore plus a handful at Rs 1,000 to 2,000 crore. With 53 companies at seed, that is a reasonable number of shots, but the 12% entry ownership is the lever: at 8% the required exit value would rise by half. The model's limits are its assumptions: the 2x on reserves, a flat 40% dilution, no hurdle and no fee step-down after the investment period. An LP should ask to see each one flexed.

Where candidates lose it

Candidates gross up Rs 1,200 crore by 20% and say Rs 1,500 crore. Carry is charged on profit above committed capital, not on the whole distribution, so the right figure is Rs 1,400 crore.

The second miss is dividing by 12% instead of 7.2%. Entry ownership is not exit ownership; ignoring the 40% dilution understates the exit value the portfolio needs by two-fifths.

What the interviewer asks next

  • Fees step down to 1% after year five. How many more companies can the fund back?
  • The fund adds an 8% hurdle with full catch-up. Does the required distribution change at 3x?
  • What if reserves return only 1x? How does the required exit value move?
  • Would you rather write 40 cheques at 15% or 60 at 10%? Why?

Company names and figures are illustrative.