Venture Capital puzzles, solved step by step
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005A Rs 100 crore fund has an 8% compounding hurdle and a 100% GP catch-up, then splits 80/20. It returns Rs 200 crore at the end of year five, in one distribution. How much does the GP get, and how much would it get without the catch-up?Fund of funds and LPsGrowth equity
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With the full catch-up, what share of the Rs 100 crore profit does the GP end up with?
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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.
The relationshipc the GP catch-up, Rs crore P the preferred return paid to LPs, Rs crore 0.20 the GP's carried interest share What it says in wordsThe catch-up is whatever makes the GP's take exactly one fifth of all the profit paid out so far.With the catch-up, the Rs 200 crore goes Rs 100 crore of capital and Rs 46.9 crore of hurdle to LPs, Rs 11.7 crore of catch-up to the GP, then Rs 41.3 crore split 80/20, so the GP ends with Rs 20.0 crore; without it the GP gets only Rs 10.6 crore. 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.
Where candidates lose it
The common slip is using simple interest for the hurdle, Rs 40 crore, which makes the catch-up Rs 10 crore and the no-catch-up carry Rs 12 crore. The question said compounding; 1.08 to the power 5 is the step people skip.
The second is thinking a 100% catch-up gives the GP more than 20% overall. It only accelerates the GP to its 20%; say that it stops once the GP is caught up.
What the interviewer asks next
- The fund returns only Rs 150 crore. Is the catch-up completed, and what does the GP get?
- How would an 80% catch-up instead of 100% change the GP's take at Rs 200 crore?
- Why do LPs usually accept a catch-up rather than a pure hurdle?
036A fund of funds charges 1% a year on commitments for ten years and takes 10% carry. It invests in venture funds that return 2.5x net to it. What does the fund of funds' LP receive per Rs 100 committed?Fund of funds and LPsMulti-stage VC
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Roughly what multiple does the LP of the fund of funds end with?
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About Rs 212.5 per Rs 100 committed, a multiple of 2.125x. Ten years at 1% takes Rs 10 in fees, so Rs 90 reaches the underlying funds. At 2.5x that becomes Rs 225. The profit over the Rs 100 committed is Rs 125, and 10% carry on it is Rs 12.5. The LP keeps Rs 212.5, so the extra layer turns 2.5x into about 2.1x.
Why does the fee cost more than its 10% headline?
Think of buying vegetables through a cousin who takes Rs 10 out of every Rs 100 you give him before he reaches the market. The vendor's prices may be excellent, but you only ever buy Rs 90 worth. Fees come out before the money is invested, so the underlying 2.5x is earned on Rs 90, not on Rs 100. Rs 90 at 2.5x is Rs 225, which is 2.25x of what the LP committed. The 1% a year looks small, but over ten years it is a tenth of the commitment that never works.
Of each Rs 100 committed, Rs 10 goes in fees, Rs 90 grows to Rs 225 in the underlying funds, and Rs 12.5 of carry leaves Rs 212.5 for the LP, so a 2.5x fund return becomes 2.125x one layer up. The relationship100 - 10 the commitment less ten years of 1% fees, the money that reaches the funds 2.5 the underlying funds' net multiple 0.10 the fund of funds' carry rate 225 - 100 the profit over the full commitment, which carry is charged on What it says in wordsGrow what is left after fees, then take carry on the profit above what the LP put in.Which layer costs the LP more, the fees or the carry?
Split the 0.375x gap between 2.5x and 2.125x. Fees cost 0.25x and carry costs 0.125x, so the fixed fee does twice the damage of the profit share at this return. That ranking flips at higher returns, because carry grows with profit while the fee does not. At 4x underlying, the same structure would cost 0.4x in fees and about 0.26x in carry. The assumption here is that carry is charged on profit over the full commitment, with fees returned first and no hurdle; a structure that charges carry from the first rupee of profit costs more.
What does an LP get for the extra layer?
A fund of funds sells access and diversification: places in funds that are hard to get into, spread across managers and years, with someone else doing the selection and monitoring. The LP should compare the net-of-everything multiple with what it could earn going direct, not compare the fund of funds' fees with zero. The limitation is that this one number hides timing. The fund of funds' fees start on day one, while the underlying funds return money late, so the gap in annual rate terms is wider than the gap in multiples suggests.
Where candidates lose it
The common loss is answering 2.5x, or subtracting 10% of fees from 2.5x to get 2.25x and forgetting the carry. Each layer of a fund structure takes something; the interviewer wants both deducted in the right order.
The second loss is charging carry on the whole Rs 225, which gives Rs 202.5 and 2.03x. Carry is a share of profit, and profit is measured against the Rs 100 the LP committed.
What the interviewer asks next
- What underlying fund multiple does the LP need to end with 2.5x after the fund of funds' fees and carry?
- How does the answer change if the fund of funds charges carry with an 8% preferred return?
- Why might an LP accept two layers of fees in a first-time emerging-manager programme?
060A fund reports a 32% IRR on a deal it exited at 1.15x after six months, and a 12% IRR on a deal that made 3.1x over ten years, each on Rs 10 crore. Which made its LPs more money, and what would the six-month deal's IRR be if the proceeds then sat idle at 0% for the rest of a ten-year fund life?Fund of funds and LPsSeed and early-stage VC
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Measured over the full ten years with the cash idle, the six-month deal's IRR is about:
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The 12% deal made Rs 21 crore against Rs 1.5 crore, fourteen times as much. The quick flip shows a 32% IRR because 1.15x in six months annualises to 1.15 squared, about 1.32. But LPs spend rupees, not rates. If the Rs 11.5 crore then sat idle for the remaining nine and a half years, the deal is 1.15x over ten years, an IRR of about 1.4%. The ten-year deal's 3.1x is about 12% a year on the whole Rs 10 crore for the whole time.
How can a 32% IRR make less money than a 12% IRR?
A cab that charges a high rate per minute for a two-minute ride earns less than a modest-rate cab hired for the whole day. IRR is a rate per year while the money is out, so a short deal can post a huge IRR on a tiny rupee profit, and the rate says nothing about how long the capital earned it. On Rs 10 crore the flip made Rs 1.5 crore. The ten-year deal made Rs 21 crore, with a lower rate sustained over twenty times as long.
On the same Rs 10 crore the six-month flip made Rs 1.5 crore and the ten-year hold Rs 21 crore, so the higher 32% IRR made one-fourteenth of the money, and measured over the fund's ten years with the cash idle it is only 1.4%. The relationshipM money multiple, what came back over what went in t years the money was out What it says in wordsFor a single cash out and a single cash back, the IRR is the multiple spread evenly across the years, so the same multiple over more years is a lower rate.Why does it matter what the cash does after the exit?
The 32% assumes the Rs 11.5 crore can be put straight back to work at a similar rate. For an LP whose money was committed for ten years, cash returned early earns only what the LP can do with it next, and if that is nothing, the deal's true rate over the commitment is about 1.4%. This is why LPs read IRR beside the money multiple, and why a fund boasting a top-quartile IRR on a 1.3x fund gets hard questions. Some funds also time capital calls with credit lines to shorten the period the money counts as out, which flatters IRR without adding a rupee.
The fair limit: early cash is worth something if the LP really can reinvest it, and the reinvestment rate decides by how much. In the room, say both numbers for every deal, multiple and IRR, and say which one an LP banks.
Where candidates lose it
The trap is to rank by IRR and pick the 32% deal. The question asks which made more money, and the answer is in rupees: Rs 21 crore against Rs 1.5 crore.
The second loss is the follow-on. Candidates who see the issue still fumble the ten-year IRR; keep it to one step, the tenth root of 1.15, and bracket it near 1.4% rather than guessing.
What the interviewer asks next
- At what reinvestment rate after exit would the quick flip match the ten-year deal's profit?
- How does a subscription credit line change a fund's reported IRR?
- Which would you report to LPs first, IRR or TVPI, and why?
092A fund invests Rs 100 and gets Rs 200 back five years later. Instead of calling its investors' money on day one, it pays for the investment with a bank credit line and calls the investors' money one year later to repay it. The exit date is unchanged. Ignoring the interest, what is the investors' IRR in each case?Fund of funds and LPsGrowth equity
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What does the credit line do to the investors' IRR and multiple?
Show the worked solution
14.9% without the credit line and 18.9% with it, and the multiple is 2.0x either way. IRR measures time as well as money. Without the line, Rs 100 doubles over five years: 2 to the power one fifth, less 1. With it, the investors' Rs 100 is out for four years, and 2 to the power one quarter, less 1, is 18.9%. Nobody made an extra rupee; with 8% interest, investors actually make less.
Why does paying later raise the IRR?
Lend a friend Rs 100 and get Rs 200 back: whether that is a good deal depends on whether it took five years or four. IRR is the yearly rate that turns the money paid in into the money paid out, so shortening the time the money is out raises the IRR even when the rupees are identical. Without a credit line, the investors' Rs 100 grows to Rs 200 over five years, 14.9% a year. With one, the investors pay at year 1 and still receive Rs 200 at year 5: four years, 18.9% a year.
The same Rs 100 in and Rs 200 out gives investors an IRR of 14.9% when they pay at year 0 and 18.9% when a credit line lets them pay at year 1, while the multiple stays 2.0x and the interest on the line, if counted, takes the multiple down to 1.85x. The relationshipM money multiple to the investors, 2.0 n years the investors' money is out, 5 or 4 What it says in wordsWith one payment in and one out, IRR is the multiple spread evenly over the years the money was at work.What happens once you count the interest?
The bank is not free. At 8% for one year, the fund calls Rs 108 at year 1 to repay Rs 100 plus interest. The investors now pay more for the same Rs 200, so the multiple falls to 1.85x, yet the IRR is still 16.7%, higher than the 14.9% without the line. Less money, better-looking IRR. That gap is why investors in a fund ask for the multiple and the IRR side by side, and increasingly ask for the IRR with the credit line stripped out.
Why would a fund use a credit line at all?
There are honest reasons: it lets the fund close a deal quickly without waiting ten business days for a capital call, and it smooths many small calls into a few large ones, which investors find easier to manage. The concern is the IRR effect. A fund that ranks high on IRR partly because of the line may have made less money for its investors than one that ranks lower. Say both reasons, then say which number you would compare funds on: the multiple, and the IRR measured from the date the investment was made.
Where candidates lose it
The first slip is saying nothing changes because the deal is the same. The interviewer is testing whether you know that IRR depends on when the investors' money moves, not just how much.
The second is thinking the higher IRR means the investors are better off. Once interest is counted they get 1.85x instead of 2.0x: the IRR rose while the money made fell, and saying that clearly is the point of the question.
What the interviewer asks next
- If the credit line is drawn for two years instead of one, what is the IRR, ignoring interest?
- At what interest rate does the credit line stop raising the IRR?
- Why might an investor in a fund still welcome a credit line?