Venture Capital puzzles, solved step by step

About 1.24x, down from 3.0x. The other 29 companies returned Rs 360 crore, an average of Rs 12.4 crore each. Replace the Rs 540 crore winner with one more average company and the fund returns Rs 372 crore on Rs 300 crore. Missing that one company costs Rs 528 crore, more than three times what all 15 write-offs cost together.

Why does one company out of thirty move the whole fund?

Picture a cricket team that scores 900 runs in a series, 540 of them from one batter. Drop that batter for an average player and the team's total collapses, however steady the rest were. A venture fund works the same way: returns are so uneven that the best company is often worth more than all the others put together. Here the winner returned 54x its cheque. The other 29 returned Rs 360 crore between them, an average of Rs 12.4 crore on Rs 10 crore each, about 1.24x.

How does that compare with the cost of the failures?

Fifteen companies went to zero. At Rs 10 crore each, that is Rs 150 crore of lost capital, the most a write-off can ever cost. A write-off loses at most the cheque; a missed winner loses everything the winner would have returned, which has no ceiling. In this fund the one miss costs Rs 528 crore, about 3.5 times every write-off combined. This asymmetry is why venture investors say the error that matters is the company they passed on, not the one that failed.

What do you add after the number?

Say what it implies for how a fund behaves. A partner who rejects a deal because it might fail is guarding against the smaller of the two errors. The right question at the investment committee is whether a company could return the fund if it works. The limit is worth one sentence too: this is one fund's numbers, and a portfolio with a flatter spread of outcomes would care less about any single company.

About 2.03, not 1.6. ARR is one year of recurring revenue, so a Rs 8 crore contract spanning three years adds Rs 2.67 crore of ARR. Net new ARR falls from Rs 25 crore to Rs 19.67 crore, and Rs 40 crore of burn divided by that is 2.03. The company spends about Rs 2 of cash for every rupee of new annual revenue, not Rs 1.60.

What is the burn multiple actually measuring?

The burn multipleNet cash burned in a period divided by the net new annual recurring revenue added in that period. Lower is more efficient. asks how many rupees of cash a company spends to add one rupee of annual recurring revenue. Both halves have to be measured over the same year, so a contract that covers three years can only put one year's revenue in the denominator. A gym that sells a three-year membership for Rs 36,000 has not added Rs 36,000 of yearly revenue; it has added Rs 12,000 a year for three years.

How do you restate it in your head?

Split the Rs 25 crore into the part that was fine and the part that was not. Rs 17 crore came from ordinary annual contracts. The prepaid contract is Rs 8 crore over three years, which is Rs 2.67 crore a year. Restated net new ARR is 17 plus 2.67, or Rs 19.67 crore, and 40 divided by 19.67 is 2.03. A quick check: 40 over 20 would be exactly 2, and the denominator is a little under 20, so the answer sits a little above 2.

Why does the gap between 1.6 and 2.03 matter?

Many investors read a multiple under about 1.5 to 2 as efficient growth and anything much above 2 as expensive, though the cut-offs vary with stage and market. The restatement moves this company across that line, from efficient-looking to expensive. It also tells you what to ask next: how many other contracts are multi-year, and whether the sales team is paid on total contract value, which would explain why the number was booked this way.

About 61%, and for an 80% chance it must start raising after month 2. The chance of failing all nine months is 0.9 to the power 9, about 39%, so it closes about 61% of the time. An 80% chance needs 0.9 to the power n below 20%, which first happens at 16 months (81.5%). Eighteen months of cash less 16 means raising from month 2.

Why not just add 10% a month?

Think of a friend who picks up the phone one time in ten. Call nine times and you will not reach them 90% of the time, because every call after the one they answer is wasted. With repeated independent tries, count the chance of failing every time and subtract it from one; adding the chances double counts the months after a close. Adding 10% a month would give 100% at ten months and more than 100% after that, which is the tell that the method is wrong.

How do you find the month it must start?

Set 0.9 to the power n below 0.2 and solve. Taking logs, n is at least ln 0.2 over ln 0.9, about 15.3, so round up to 16 whole months. Fifteen months gives 79.4%, just short of 80%, and sixteen gives 81.5%. With 18 months of cash, sixteen months of raising means starting after month 2. Doubling the time spent raising only lifts the odds from 61% to about 81%, because each extra month adds 10% of a shrinking remainder.

What would you say to a founder about this?

The model is simple and its lesson is not: fundraising odds climb slowly, so a company that waits until half its runway is gone has already given up a large share of its chances. The limitation is worth naming. Real months are not independent; a round that has not closed in six months usually gets harder, not equally likely, so the true curve is flatter still.

About 3.85% of the company. Seed leaves the founder at 80%. The Series A investor and the new pool take 35% of the post-money together, so existing holders keep 65%, and the founder goes to 52%. To stay at 50%, the founder can keep no less than 50 over 52 of the Series B cap table, so the Series B can sell at most 1 minus 50/52, about 3.85%.

Why does dilution multiply rather than subtract?

Think of a pizza you own whole. Give a friend a fifth and you keep four fifths. If the pizza is then cut again and newcomers take a third of every slice, you lose a third of what you still hold, not a third of the original pizza. Each round shrinks every existing holder by the same factor, so the founder's stake is the product of the factors, not 100% minus the percentages sold. Subtracting 20, 25 and 10 from 100 gives 45% and is wrong for exactly this reason.

How do the Series A investor and the pool combine?

Both are measured on the post-money cap table of the same round, so they come out of the same pie at the same time. Existing holders keep 100% minus 25% minus 10%, which is 65%, and the founder goes from 80% to 52%. Had the terms said the pool was created after the investor bought in, you would chain them instead, 0.75 times 0.90, and the founder would hold 54%. Asking which way the pool is measured is the question that separates candidates here.

How big can the Series B be?

The Series B shrinks the founder by a factor of one minus whatever it sells. The founder stays at or above 50% only if 52% times (1 minus x) is at least 50%, which gives x of at most 1 minus 50/52, about 3.85%. That is a tiny round. In practice it tells you the founder's goal and a normal Series B, which often sells 15% to 25%, cannot both happen.

Rs 20 crore with the catch-up, and about Rs 10.6 crore without it. LPs first get their Rs 100 crore back plus an 8% compounding return, Rs 46.93 crore. The GP then takes the next Rs 11.73 crore until it holds 20% of the profit so far, and the last Rs 41.33 crore is split 80/20. Without the catch-up, only the Rs 53.07 crore above the hurdle is split, and the GP gets 20% of that.

What order does the money flow in?

A distribution waterfallThe agreed order in which a fund pays out cash: which party is paid first, how much, and when the next tier begins. is a queue at a buffet: each tier eats fully before the next is served. Tier one returns the LPs' capital, tier two pays them the hurdle, tier three is the GP's catch-up, and only then does the 80/20 split begin. The hurdle compounds, so after five years it is 1.08 to the power 5 minus 1, about 46.9% of capital, Rs 46.93 crore, not the Rs 40 crore that simple interest would give.

How big is the catch-up, and why does it stop where it does?

The catch-up pays the GP 100% of the next money until the GP holds 20% of all profit paid so far. If the catch-up is c, then c must equal 20% of the hurdle plus c. Solving gives c equal to the hurdle times 0.20 over 0.80, one quarter of Rs 46.93 crore, which is Rs 11.73 crore. At that point LPs hold 80% of profit and the GP holds 20%, so every later rupee split 80/20 keeps those shares fixed.

What is the catch-up worth to the GP here?

Without it, the GP earns 20% only of the Rs 53.07 crore above the hurdle, Rs 10.61 crore. The catch-up nearly doubles the GP's take, from about Rs 10.6 crore to Rs 20 crore, because it gives the GP its share of the hurdle profit back. The limit to say aloud: this is one distribution at year five. Real funds pay out over many years, and the hurdle runs on each rupee's own timing, which changes the numbers but not the order.

About 381 companies a year. The four pass rates multiply to 0.525%, so only one sourced company in about 190 becomes a closed deal. Working backwards: 2 deals need 2.86 term sheets, 19 partner meetings and 76 first meetings, which need 381 companies in the top of the funnel. That is seven or eight new companies every week of the year.

Why do the pass rates multiply?

Think of a college admission that needs you to clear a written test, then an interview, then a document check. If one applicant in five clears the test and one in four of those clears the interview, only one in twenty of the original applicants is still standing before the document check even starts. Each stage of a funnel acts only on what survived the stage before it, so the overall rate is the product of the stage rates, not their sum or average. Here that product is 0.20 x 0.25 x 0.15 x 0.70, which is 0.00525, or about one company in 190.

How do you say it out loud without losing the room?

Work backwards from the answer the interviewer cares about, one stage at a time, and say each number as you go. Two closed deals at a 70% close rate need 2.86 term sheets; at 15% that is 19 partner meetings; at 25% that is 76 first meetings; at 20% that is 381 companies. Then translate it into a working week: 381 over 52 is about 7.3 new companies a week and about one and a half first meetings a week, which is a concrete picture of the job.

Keep the fractions until the end. If you round up at every stage instead, you get 3 term sheets, 20 partner meetings, 80 first meetings and 400 companies, a 5% overshoot from rounding alone. It is not a disaster, but it shows the interviewer you carry precision until the last step.

What would you add after the number?

Point at the stage with the most leverage. Every rate matters equally in the product, but they are not equally easy to move. Lifting the partner-meeting rate from 25% to 35%, by screening harder before first meetings, cuts the sourcing need to about 272 companies. The limitation is worth a sentence too: real funnels are lumpy, and a fund that closes two deals a year will see years with one and years with four.

About 5 months. Both flows are a share of the same base, so the base grows by 20% minus 5%, a net 15% a month, and that 15% compounds. The rule of 72 gives 72 over 15, about 4.8 months; the exact answer is ln 2 over ln 1.15, 4.96 months. A check: 1.15 to the fifth power is 2.01.

What is the real growth rate here?

Picture a water tank with a tap pouring in and a small leak at the bottom. How fast the tank fills depends on the tap minus the leak, not on the tap alone. When new users and lost users are both a share of the same base, the base grows at the difference between the two rates, here 20% minus 5%, or 15% a month. The 20% is the headline the founder will quote; the 15% is the number that moves the base.

Why is it not 100 divided by 15, about 6.7 months?

Because each month's 15% is taken on a bigger base than the month before. Adding 15 percentage points a month treats growth as a straight line; compounding means month five adds 15% of 1.75 lakh, not 15% of 1 lakh. The base is 1.75 times its start after four months and 2.01 times after five, so it crosses double just before the end of month five. The rule of 72 gets you to 4.8 in your head, which is close enough to say first and refine.

What should you say about the assumption?

Say that you assumed both rates apply to the same opening base each month and stay constant. If churn rises as the app reaches less engaged users, which is common, the doubling time stretches quickly: at 8% churn the net rate is 12% and doubling takes 6.1 months. The flow picture also tells you something the headline does not. Users lost each month grow with the base, so a leak that looks small at 1 lakh users is twice as large in absolute terms at 2 lakh.

A post-money of Rs 60 crore, and a Rs 12 crore cheque needs 20% of the company. Rs 1,000 crore divided by 10 is Rs 100 crore, but later rounds leave you with only 60% of your stake, so the price falls to Rs 60 crore. Rs 12 crore buys 20% at that price, which dilutes to 12% by the exit and is worth Rs 120 crore, exactly 10x.

Why work backwards from the exit?

A shop owner who knows a sari will sell for Rs 10,000 and needs to double her money can pay the weaver at most Rs 5,000. She starts at the selling price and divides. A venture investor does the same: start at the exit value, divide by the multiple you need, and what is left is the most the company can be worth when you buy in. Here that is Rs 1,000 crore over 10, Rs 100 crore, before you account for what later rounds do to your stake. This is often called the venture capital method.

Where does the dilution go in the chain?

Later rounds do not change the exit value; they shrink the share of it you own. If you hold 20% today and keep 60% of it, you own 12% at the exit. Because you only collect 60% of the stake you buy, the company must be priced at 60% of the undiluted figure for the maths to work, Rs 60 crore post-money rather than Rs 100 crore. Rs 12 crore at Rs 60 crore post is 20%, and the pre-money is Rs 48 crore.

What do you add to show judgement?

Translate the multiple into a yearly rate and question the inputs. 10x over six years is about 47% a year, and the whole answer leans on a single exit value that is far from certain. If only one company in three reaches that exit, the honest calculation uses an expected exit, and the price you can pay falls by the same factor. Saying that sentence turns a formula into an investment view.

Series B takes its Rs 60 crore preference and Series A converts. Converting would give Series B at most Rs 45 crore, so it takes its money back. That leaves Rs 140 crore for Series A and common, who hold 20% and 60% of the shares; Series A's quarter is Rs 35 crore, beating its Rs 20 crore preference. Common receives Rs 105 crore.

How does a non-participating holder decide?

Think of a refund policy: you can take your money back, or keep the product and its resale value, but not both. A non-participating preferred holder takes the larger of its preference or what its shares are worth as common, never both. Two series holding the same 20% each face very different choices here, because Series B paid Rs 60 crore for its 20% and Series A paid Rs 20 crore. Series B's refund is worth three times as much, while their shares are worth the same.

Why does Series B not convert, whatever Series A does?

Test its best case. If Series A takes its preference, Series B converting would share Rs 180 crore with common, 20 parts of 80, which is Rs 45 crore. If Series A also converts, Series B would get 20% of Rs 200 crore, Rs 40 crore. Both are below Rs 60 crore, so Series B takes its preference however Series A behaves. That settles the order: take B's Rs 60 crore off the top first, then decide A.

Where are the break points if the sale price moves?

Series A converts once a quarter of what is left after Series B exceeds Rs 20 crore, which is any sale above Rs 140 crore. Series B converts only once 20% of the whole sale exceeds Rs 60 crore, above Rs 300 crore. Between Rs 140 crore and Rs 300 crore, the two series that own the same stake are treated differently, and Rs 200 crore sits inside that band. Below Rs 80 crore, pari passu means the two preferences share the proceeds in proportion to Rs 20 crore and Rs 60 crore, one part to three.

Light fuse A at both ends and fuse B at one end, at the same moment. Fuse A burns out after exactly 30 minutes, because two flames use up its hour twice as fast. At that instant fuse B has 30 minutes of burning left, so light its other end too. It goes out 15 minutes later, at exactly 45 minutes.

Why does lighting both ends give exactly 30 minutes?

Think of two people eating from opposite ends of a plate of biryani that one person would finish in an hour. One may eat faster on the rice and slower on the meat, but together they always clear the plate in half the time. A fuse holds a fixed amount of burning time, 60 minutes, and two flames consume it at twice the rate of one, so they meet after 30 minutes wherever along the fuse that happens to be. The unevenness only moves the meeting point.

Why light fuse B at the start rather than later?

Fuse A is your clock for the first 30 minutes, and fuse B needs to spend those same 30 minutes burning so that exactly half its burn time is left. The trick is that fuse B stores time: after 30 minutes on one flame it holds exactly 30 minutes of burn, whatever its length, and a second flame halves that to 15. Lighting B only when A goes out would leave it with a full hour, and you could only measure 60 or 90 minutes from there.

What is the interviewer actually listening for?

Whether you separate what you know from what you do not. You do not know the burn rate along the fuse, so any plan that cuts or measures it by length is dead. You do know the total time, and the answer uses nothing else. That habit carries over to diligence: when a company's monthly numbers are noisy, lean on the totals you can verify rather than on a rate you are guessing.