A venture capital fund’s performance can be evaluated by looking at two groups of metrics:
(1) ratios or multiples of the capital invested; and
(2) by looking at the internal rate of return (IRR)
These metrics can then be compared to benchmarks like the performance of comparable funds (to measure quartile performance) or their public market equivalent (such as the S&P 500 or Nasdaq). This blog will look at the first group of metrics — ratios or multiples of the capital invested. These are the Distributions Per Investment (DPI), Residual Value to Paid In capital (RVPI) and Total Value to Paid In capital (TVPI).
DEFINITIONS
Prior to jumping in, some key concepts need to be defined:
- Limited Partners (aka LPs)— provide capital to invest in a fund
- General Partners (aka GPs) — managers of a fund
- Committed capital — amount of capital that the LP agrees to provide for a fund
- Paid-in-capital (aka contributed capital)— committed capital drawn down over time by GPs as investments are made in the fund
- Carried interest — a percentage of the fund’s profits earned by the general partners of a fund
- Gross returns vs net returns — gross returns are the cash and stock gained by the fund upon exiting the investment and don’t account for carried interest, management fees and expenses (e.g. legal, marketing). The below discussion is based on net returns.
RATIOS
DPI — Distributions Per Investment
Also known as a realisation multiple, it measures how much money has been distributed by the fund to the LPs. The ratio starts off low and increases as the fund matures and investments are exited. A DPI of 1x means that the LP has received the same amount as the paid-in-capital; whereas a 2x means that the LP has received twice the amount of paid-in-capital.
RVPI — Residual Value to Paid In capital
It is the ratio of current value of all remaining investments in a fund plus any cash equivalents to the paid-in-capital. It is a measure of how much capital that is yet to reach an exit. While DPI is a measure of performance to date; RVPI could show how good a fund may be in the future.
TVPI — Total Value to Paid in Capital
Also known as Investment Multiple or Multiple of Invested Capital (MOIC). It provides an estimated return per dollar invested. It is the sum of DPI and RVPI. Once the fund closes, this ratio equals the DPI as there are no on-ongoing investments and the residual value equals 0.
LIMITATIONS TO USING RATIOS
- Interim vs final performance —private equity funds have maturity dates between 7 to 13 years and sometimes going to 16+. Distributions that are made early in the fund’s life are highly variable. That is, the early, interim performance should not be taken as a predictor of final performance — which is when all investments have been realised, distributions have been made to LPs and the fund has been liquidated. Interim performance becomes a more reliable indicator of final performance after 5 to 7+ years as the distributions become more stable.
- Time value of money — ratios or multiples don’t consider this as they are an indicator of a fund’s performance at a snapshot in time. That is, a TVPI multiple of 2x at year 14 of a fund’s life may not be a good result whereas the same multiple at year 7 years will be a lot better.
- Residual value relies on estimates— these are estimates of the remaining value of the portfolio investments that haven’t been sold. The challenge here is that company valuations change as the company matures. The estimates that go into building the valuation can be subject to a lot of variability.
