Venture Capital puzzles, solved step by step

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  1. 017A Rs 300 crore fund distributes Rs 900 crore over its life. The GP earns 20% carried interest on profits above returned capital, with no hurdle, and you can ignore management fees. What is the carry, and what are the fund's gross and net multiples?Fund economics riddlesWarm upFund of funds and LPsSeed and early-stage VC

    Try it first

    What multiple do the LPs actually receive?

    Show the worked solution

    Carry is Rs 120 crore, and the fund is 3.0x gross and 2.6x net. The profit is Rs 900 crore less the Rs 300 crore of capital returned, Rs 600 crore. The GP takes 20% of that, Rs 120 crore. LPs receive Rs 780 crore on Rs 300 crore, which is 2.6x, against 3.0x for the portfolio before carry.

    What is the carry charged on?

    Think of a tutor paid a fifth of whatever a student's marks improve by, not a fifth of the total marks. Carried interest is a share of the profit, so the LPs' own capital comes back to them first and only the gain above it is split. The fund returned Rs 900 crore on Rs 300 crore, so the gain is Rs 600 crore and the GP's 20% is Rs 120 crore. A hurdleA minimum return LPs must receive before the GP earns any carry. This fund has none. would delay the carry but, once caught up, would not change its size at this level of return.

    Carry takes 20% of the profit, not of the money returned900Distributions3.0x gross-300Capital backto LPs600Profit-120Carry to GP20% of 600480LP profitGross3.0xNet to LPs2.6x780 / 300
    Of Rs 900 crore distributed, Rs 300 crore returns the LPs' capital and Rs 600 crore is profit; the GP takes 20% of the profit, Rs 120 crore, so LPs receive Rs 780 crore, 2.6x net against 3.0x gross.

    Why is net 2.6x and not 2.4x?

    Taking 20% off 3.0x would charge carry on the capital as well as the profit. The gap between gross and net is 20% of the profit multiple, 0.2 x 2.0, which is 0.4 turns, so 3.0x gross becomes 2.6x net. The same logic gives a quick rule: at any gross multiple M with 20% carry and no fees, net is 1 plus 0.8 x (M minus 1). A 2.0x gross fund nets 1.8x; a 5.0x fund nets 4.2x.

    The relationship
    Mnet=1+(1−0.20)(Mgross−1)=1+0.8×2.0=2.6M_{net} = 1 + (1 - 0.20)(M_{gross} - 1) = 1 + 0.8 \times 2.0 = 2.6
    M_grossdistributions over committed capital before carry, 3.0x
    0.20the carried interest rate
    M_netwhat LPs receive over what they put in
    What it says in wordsLPs get their money back plus 80% of every turn of profit.

    What would an LP add?

    That fees push net lower still. A typical venture fund also charges an annual management fee on committed capital, often around 2% for the investment period, which reduces both the money invested and the net multiple; confirm the actual terms in the fund's agreement. An LP compares managers on net multiples and net IRR, because that is the only number that reaches its own balance sheet. A GP quoting 3.0x is quoting the portfolio, not the investor's outcome.

    Where candidates lose it

    The fast wrong answer is 2.4x, taking a fifth off the gross multiple. It charges carry on the LPs' own capital, and an interviewer from an LP or a fund will spot it at once.

    The quieter miss is mixing up gross and net. Say both numbers and which one the LPs see.

    What the interviewer asks next

    • With an 8% hurdle and a full catch-up, does the carry change at 3.0x?
    • If management fees total Rs 45 crore over the fund's life and come out of committed capital, what is the net multiple?
    • Why do LPs care about net IRR as well as net multiple?
  2. 072A venture fund has called Rs 200 crore from its LPs, distributed Rs 150 crore back to them, and holds a portfolio marked at Rs 350 crore. What are its DPI, RVPI and TVPI, and which one should an LP trust most?Fund economics riddlesWarm upFund of funds and LPsMulti-stage VC

    Try it first

    What are DPI, RVPI and TVPI?

    Show the worked solution

    DPI 0.75x, RVPI 1.75x, TVPI 2.5x. All three divide by the Rs 200 crore paid in. Distributions of Rs 150 crore give a DPI of 0.75x; the Rs 350 crore still held gives an RVPI of 1.75x; the total value of Rs 500 crore gives a TVPI of 2.5x. An LP trusts DPI most, because it is cash already returned. The fund looks like a 2.5x but has not yet given back the money it called.

    What does each ratio measure?

    A friend who borrowed Rs 2,000, has repaid Rs 1,500 and promises the rest plus Rs 3,500 more from a deal still underway has given you back 0.75 times your money in cash and promised 1.75 times more. DPIDistributions to paid-in capital: cash returned to LPs divided by capital called. counts cash returned, RVPIResidual value to paid-in capital: the portfolio's current marked value divided by capital called. counts value still on paper, and TVPI is the two added together, all divided by the capital called. The fund called Rs 200 crore, so DPI is 150 / 200 = {dpi72:.2f}x, RVPI is 350 / 200 = {rvpi72:.2f}x and TVPI is {tvpi72:.1f}x.

    TVPI is 2.5x, but only 0.75x of it is cashPaid inRs 200 cr calledValueRs 150 cr cashRs 350 cr marked, not cash1x2xDPI150 / 200 = 0.75xcash backRVPI350 / 200 = 1.75xon paperTVPI500 / 200 = 2.5xthe two together
    Against Rs 200 crore paid in, the fund has returned Rs 150 crore of cash and holds Rs 350 crore on paper, so its TVPI is 2.5x but only 0.75x of it is money LPs have actually received.
    The relationship
    TVPI=DPI+RVPI=150200+350200=0.75+1.75=2.5\text{TVPI} = \text{DPI} + \text{RVPI} = \frac{150}{200} + \frac{350}{200} = 0.75 + 1.75 = 2.5
    DPIdistributions over paid-in capital
    RVPIremaining marked value over paid-in capital
    TVPItotal value, cash plus marks, over paid-in capital
    What it says in wordsDivide cash returned and value still held by the capital called; the two add up to the fund's total multiple.

    Why does an LP care more about the 0.75x than the 2.5x?

    Because the marks can move and the cash cannot. RVPI rests on the fund's own valuation of private companies, often at the last round's price, so 70% of this fund's reported value is an estimate that has not been tested by a sale. If those marks fell 40%, RVPI would drop to 1.05x and TVPI to 1.8x, while DPI would stay at 0.75x. That is why many LPs judge older funds on DPI, and why the phrase 'DPI is the only metric that counts' gets repeated in fundraising conversations.

    The fair limit is timing. A young fund naturally has low DPI because its companies have not been sold yet; judging a three-year-old venture fund on DPI alone would punish every fund for being young. Read DPI against the fund's age, and ask how the marks were set, last round, a comparable, or a recent offer, before trusting the RVPI.

    Where candidates lose it

    The usual slip is dividing by the wrong base: by the fund's total commitments instead of capital called, or dividing distributions by the NAV. Every ratio here shares the same denominator, the money LPs have actually paid in.

    The second loss is stopping at the three numbers. The interviewer wants the judgement: 2.5x is mostly paper, and the fund has not yet returned the capital it called.

    What the interviewer asks next

    • If the portfolio marks fell 40%, what would TVPI be?
    • Why might a young fund show a high TVPI and a DPI near zero?
    • How would you test whether the Rs 350 crore of marks are fair?