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Venture Capital Metrics: How VC Firms Get Measured

Whether you are an investor looking to partner with a venture capital (VC) firm, or a startup looking for the perfect venture firm to get your startup off the ground, it is important to know how to choose a good firm. 

There are a multitude of ways in which VC firms get measured and knowing the ways they are measured can help both prospective startups and investors better understand what a venture capital firm has to offer. The specific quantitative metrics tell part of the story of a VC firm yet it is not the end all be all solution to measuring the firm. 

Measuring a VC firm involves discerning its value both quantitatively and qualitatively where the perceived value of the firm is measured from the perspective of a prospective investing partner or a prospective startup. With all of these viewpoints, metrics, and valuations, a clearer picture is able to be made of how successful a VC is to both investors and founders.

What is a Venture Capital Firm?

The term venture capital tends to get thrown around a lot in the discussion of startups, but knowing exactly what a venture capital firm is can allow for a better understanding of how they get measured. 

A VC firm is a corporation that offers funding and capital to aspiring businesses and startups. In return for getting funded, a VC firm gets equity or a stake in the startup. 

The goal for a VC  firm is to make an initial investment to allow the business to grow. Once the business is successful, a VC firm will execute an exit strategy where they sell the equity in the company for profit. 

In this manner, a VC firm is looking for a business that shows a high likelihood of success, that will grow rapidly, and will provide a return on investment. There are many VC firms and each has their own unique criteria for choosing investments and which risks to take and which to pass on. 

A VC firm gets funding through investment partners that buy into the firm’s investment strategy. In return, investors seek a return on investment. 

VC firms take on quite a bit of risk investing in early businesses, but with a good investing strategy, a VC firm is able to ensure their partners are always taken care of and get a return on their investment. In this way VC firms act as a stockbroker of sorts that deals with the nitty-gritty of investing and allows the investor to relax and wait for a return. 

A good VC firm is one that offers funding but also aids a startup and builds them from the ground up.

M13 is a perfect example as they offer full funding and a team dedicated to getting a startup ready by providing resources, networking, market insights, and advising. 

VC firms that become active participants in the process of their investment companies are the ones that are able to facilitate a successful startup and a successful business venture. Those that choose to simply sit back and back a startup with hopes for a payout are less likely to achieve results and offer much less value to a startup. 

A VC firm in essence is the means for startups and ideas to become full-fledged businesses without having to come up with an enormous amount of capital by themselves. 

Why Measure VC Firms?

Venture capital firms are like any other business and as such have specific metrics that give insight into how effectively they work. For businesses, this includes metrics that have both a qualitative and quantitative value. Metrics like profit, customer satisfaction, and growth are metrics that both VC’s and standard businesses share. 

There are however metrics that are specific to VC firms, which will be discussed further on. 

Measuring VC firms (and any business for that matter) is about trying to get a glimpse into key aspects of the firm and trying to gain a general idea of how they work, how well they work, and if they drive success. 

A VC firm has to take on quite a bit of risk when making investments, and navigating which risks are worth taking is a fine skill that needs to be tuned. Through metrics, you are able to understand if the strategy of the firm is one that gives results and return on investment. These metrics can also allow one to see how much relative risk a firm is willing to take on. 

As a potential startup, it is important to understand the relative success rate of proposed venture capital and is an additional reason why a VC l firm should be measured. 

For example, if a startup is looking for a VC firm to gain funding and is presented with two VC firms that are interested, having reliable measures of success for each can make the decision process much easier. A startup can also look at a firm’s portfolio to better understand their investment strategy or investment thesis. 

It is better to look at the percentage of true successes with a venture capital portfolio because failure rates can get ambiguous quickly. The definition of a “failed” investment can mean different things to different VC firms, and getting metrics on these can be confusing and ultimately not tell the true story. 

For example, if a VC firm only considers investments that failed to make a return on investment, their numbers will most likely be lower than if they considered a failure to be any investment that does not make a return within 3 years on the initial investment. 

How Are They Measured?

Venture capital firms are measured in many different ways. The specific ways a venture capital firm is evaluated depends greatly on the viewpoint of the individual(s) seeking investment. . 

From the viewpoint of a VC firm, the values that are most typically worried about are the relative success based on investing strategy, the average return on investment, and the average time until return. These values allow a venture capital firm to understand if they are succeeding in delivering profit to investors and if their investment strategy has the success to back it up. 

From the viewpoint of a startup, a VC firm can get measured in a quite different manner. Rather than being concerned with ROI, startups should be more concerned with the results that a VC firm offers to startups. 

Additionally, as a startup, evaluating a VC firm based on its non-monetary value is essential. The more resources and value a VC firm can add to your startup, the higher it  will be measured from the perspective of a startup. By providing resources like networking, talent pools, market insights, and empowering culture, a VC firm can increase their value to startups and make themselves a much more appealing option for getting startups up and running

The more conventional ways in which a VC firm gets measured is through their qualitative and quantitative-based valuation and finances. These two factors together constitute the worth of a VC firm and both are incredibly important to consider. Qualitative analysis involves the comparison of one firm to another or one firm’s success rate to that of national averages. These comparative models allow for a way to gauge how different VCs stack up to one another based on specific qualifiers. 

Qualitatively

When valuing something or trying to discern the inherent value a business has to offer, many items are not necessarily quantifiable. 

For a VC firm this is incredibly true, as many measures of a good firm do not have to do with the numbers. 

The first aspect in which a VC firm can be measured qualitatively is by the VC firm’s team. A team that is full of bright, motivated and uplifting people are all signs of a good VC firm. Firms that take care of their clients are the ones that are more likely to facilitate success. 

Another way in which VC firms are measured is through the non-monetary value they can provide to clients. This includes business planning, access to talent pool search, access to industry leaders and insights, and much more. 

All of these add immense value to a startup and is what makes the share of startup equity even more worth it. 

Ultimately a VC firm buys a part of the company, and the more they own, the more a firm is willing to assist since they have an intrinsic motivation to do so. 

Quantitatively

Qualitative data is perhaps the most trustworthy way of measuring a VC firm and its relative success, as numbers typically do not lie. Below are three different quantitative metrics that are able to paint the picture of how a VC firm is performing. Many different metrics must be utilized when measuring a business as no one metric will adequately measure and elucidate how a business is performing. 

A Total Value to Paid-In-Capital multiple (TVPI) is a metric that gives an estimate to return per dollar invested via a multiple. Essentially a TVPI multiple of 2 signifies that for every dollar invested, the investor gets 2 dollars in return. This metric is useful because it can determine how well the investment strategy is working for them. Lower TVPI can mean the venture capital firm is about seeking many routes of investments, and avoiding any one huge stake in a business they invest in, or that they have a less than ideal investment strategy. As a VC firm partner, generally you want the TVPI to be higher as it indicates a larger return on your capital investment into the firm. A startup can utilize this information to determine at what return a VC firm is expecting to get on their investment. With this knowledge, a startup can create goals to attain this return multiple, and ensure the firm gets their money back and then some in thanks for getting their company off the ground. 

Distributions to Paid-in-Capital (DPI) is a metric that describes how much money has been made by the firm through investments. Essentially this value is analogous to a return on investment. This is a great way to determine how successful a VC firm is in its investment strategy. It should be noted that this metric fails to describe what capital is still left tied up in equity of other businesses. This poses a problem because a historically good VC firm could make a large return on investment yet change their investment strategy, resulting in investment companies that all stagnate. Startups that stagnate are not accounted for in DPI since they are still considered in process and are not considered in the failure rate. This is where RVPI comes in. 

Residual Value to Paid-In-Capital (RVPI) is how much investor capital is still tied to stakes in a startup. The RVPI is a way to gauge how many current partners a VC firm has and how much capital investments it has that have yet to reach an exit. This value can give information as to how far stretched a firm is and can dissuade both investing partners and startups. Generally a VC firm should want a relatively fast turn around and a relatively fast startup success. As a startup, a high RVPI could signal that the non-monetary value a firm has to offer may be less since these resources will be thinly spread over a larger number of startups.  RVPI is also able to make a DPI metric have more meaning. Combined the two are able to determine how good a VC firm’s investment strategy was and is in the moment. 

Conclusion

Overall, a VC firm has many ways of measurement and valuation. From looking at TVPI to understanding non-monetary value, a VC firm is quite complex, and measuring the firm requires a holistic approach to measurement. Both capital investors and startups rely on VC firms. Learning how VC firms get measured allows for a better understanding of how to select a firm. 

Businesses like Snapchat, Daily Harvest, and Thrive Market would not exist without the value provided by M13, a venture capital firm that offers more than full funding. 

Knowing how to evaluate VC firms allows one to discern the difference between a firm that is looking to turn a profit versus a firm that is looking out for the client’s best interests and provides more than simply monetary value. 

Sources

https://hbr.org/2013/05/how-to-negotiate-with-vcs

https://www.wsj.com/articles/SB100008723

https://docs.preqin.com/misc/Performance_Ratios_and_Example

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