In February 2020, Leta Capital announced the results of its very first fund launched in 2012. A series of metrics were disclosed by which venture capitalists and their investors consider the effectiveness of the results. In this article, I decided to explain in more detail, using our current funds under management as an example, what these metrics mean, how they are calculated and what you should pay attention to.
In particular, we will together explore the following terms:
- DPI (Distribution to Paid-in-Capital)
- RVPI (Residual Value to Paid-in-Capital)
- TVPI (Total Value to Paid-in-Capital)
To begin with, we’ll take a closer look at the simplified structure of the fund’s cash flow and terminology.
«Paid-in Capital» is the amount of cash from LPs (Limited Partners — investors of the Fund) deposited into the Fund’s account. You can also meet the terms “called capital”, “contributed capital”, etc. — which have the same meaning. This indicator is not equal to the declared size of the fund (“Committed Capital”). Typically, VC-firms managers do not immediately request the subscription amount in full, but only call for the necessary sums for Fund activities during its lifecycle.
For example, the full subscribed size of the Leta Capital Fund, launched in 2018, is US$ 50M, which our LPs are obligated to invest. This money actually wire to the Fund’s account by parts for specific transactions and tasks when it’s called. At the time of writing the amount of Paid-in Capital was less than US$ 30M, and our investors remain obligatory (“hard commitment”) to invest an additional $20M.
“Distribution” is the amount of cash or other liquid assets paid to investors. Usually, distribution arises after a sale of portfolio companies or if some of them are paying dividends. In case of venture capital funds, such payments are usually nonexistent at the beginning of their life cycles in the first 3–4 years, when the fund only begins to build up the portfolio. The first distribution takes place after an active investment stage has been finished.
The initial Leta Capital Limited fund, operating since 2012, paid out US$ 19 million from sale of portfolio companies and dividends from them during the period from February 2012 until February 2020.
«Residual Value» is the remaining value of the fund at present. It is calculated as the value of the remaining portfolio under management plus other assets of the fund (for example, the cash on the fund’s accounts) minus the fund’s obligations for other payments.
At the time of writing Leta Capital Limited still has 14 operating companies in the its portfolio. Our shares in those companies are valued at approximately US$ 22M. Leta Capital Fund portfolio consists of 12 companies, the total value of our shares is about $ 70M. Typically, the Residual Value of venture capital funds at the beginning of the cycle increases, reflecting the investments made and their value growth, and then begins to decrease over time as the fund sells its portfolio.
«Total Value» is the total amount of assets sold and residual assets.
The relationship between these metrics is quite simple and does not require extraordinary Math skills:
Total Value = Distribution + Residual Value
These metrics help to build indicators of the venture capital fund to estimate its performance.
DPI (Distribution to Paid-in-Capital). This multiplier, as the name clearly implies, reflects the ratio of capital already distributed between LPs to the contributed capital at the calculation date.
DPI = Distribution/Paid-In Capital
This is one of the most important indicators, since it reflects the real, and not potential, return of funds invested by its LPs. DPI = 1х means that investors have already returned all the money invested. A good result for the venture capital fund investing at the early stages at the end of its lifecycle (8–10 years) is a 3x return. It is the target performance that most VC managers aim at when calculating their portfolio strategies.
I would like to emphasize that DPI is especially relevant at the end of the funds’ lifecycle when investors have mostly executed their obligations and the fund has already begun exiting portfolio companies. At the same time, DPI> 1 at the beginning of the investment cycle may be misleading.
For example, a fund with a size of US$ 50M can call from investors only $ 1M, make a quick investment, and sell in one year for $ 4M, without making any other investments. In this scenario, DPI = 4x looks great, but that does not mean that the same DPI will be made for the entire $ 50M.
RVPI (Residual Value to Paid-in-Capital) is calculated similarly to the previous one:
RVPI = Residual Value /Paid-In Capital
RVPI is mainly used to estimate the performance of the fund at the beginning and middle of its lifecycle, as it reflects the growth of the portfolio value and the “paper” efficiency of investing activities. RVPI provides an understanding of portfolio potential and future investor returns but apparently does not guarantee it.
TVPI (Total Value to Paid-in-Capital) is not too complicated either and it is calculated as follows:
TVPI = Total Value/Paid-In Capital
It is easy to spot that TVPI can also be calculated as:
TVPI = DPI + RVPI
TVPI reflects the ratio of the sum of the distributed and undistributed assets of the fund to the capital invested by LPs, thereby showing the “virtual” profitability for the investors, which they could get if they instantly sold the entire portfolio. In practice, however, it can’t be done.
What to pay attention to
So, we got the terms and meanings and calculation rules of funds performance metrics, now let’s figure out what to do with them. An undoubted advantage is a widespread usage in the Private Equity world and ease of calculation, but there is also a lot of nuances here.
Metrics become indicative only over a rather long period.
As I described in the DPI example, the earliest results of the fund performance far from always correlate with its long-term performance. Even more so until the fund is finally closed, its results are always intermediate and definitely will be changed over time. Moreover, the DPI, in the case when the fund is fully deployed, can only grow (with rare exceptions such as fines, etc.), while RVPI and, even more so, TVPI may well decrease for many reasons.
RVPI / TVPI are highly dependent on the VC firm’s portfolio valuation methodology.
Evaluating startups is more like art / magic / shamanism (choose whatever you like) rather than science, and the Residual value, respectively, depends on the internal rules by which a VC firm evaluates its portfolio.
Leta Capital makes a positive revaluation of assets in two cases — when a liquidity event occurs (for example, a new round of investments, a partial buyback, etc), or if startup starts generating stable dividend payments, to which industry multiples on Net Profit can be applied. Negative revaluation (up to the writing-offs) — in the case of downrounds, a long absence of positive dynamics in business metrics, etc. But at the end, the real valuation of a portfolio company upon exit can turn out to be either much less or much higher than the internal Residual value, which will obviously make big changes in TVPI.
The performance of current funds does not guarantee the same results in the future.
Portfolio results can be influenced by many factors, including macroeconomic ones. Therefore, the funds’ performance is usually compared on the basis years of the years of launching(“vintage year”). Benchmarks can be found, for example, in Cambridge Associates researches.
Such data will give an idea of the past achievements of the management team, in comparison with other players in the market at that time. Unfortunately, that does not mean at all that the VC managers who made 5–6x on the funds launched in 1994–1996 can perform equally game on the funds 2010s vintage.
At the end of the day, from a financial point of view, DPI is the most significant metric. Investors can’t feed your family with RVPI , no matter how large it is.
Therefore, as we always say to our portfolio companies: “money on your bank account is the most relevant indicator that what you are doing is necessary for someone and you are doing it right”, and this is how we, VC fund managers, should treat the money of our investors as well.
Want to learn more about the internal processes of VC funds? What are the other performance metrics out there? Is it interesting to understand how the IRR of the project differs from the IRR of the fund and the IRR to the final investors? Subscribe to our blog, ask questions in the comments or reach out to me directly.