# Why is Venture Capital hard?/July 15, 2016by Dimitra Taslim

Here is an oversimplistic explanation of why venture capital is hard. WARNING: toddler algebra ahead.

Institutional investors, such as pension funds and insurance corporations, invest into venture capital funds. A minimum "respectable" return for a VC fund is typically 20% per year. This is set by the expectations of the investors in the VC funds and the relative risk levels compared to other investment classes. Another way to look at this is that a 10-year VC fund needs to return investors 6 times their investment. So if an investor invests 100x into a VC fund, they expect about 600x return.

The fund management company, a.k.a. the "venture capitalist", manages the 100x worth of investors' money and chooses the startups to invest into. They also look after the startups and help them grow. The "venture capitalist" charges investors 2% annually as management fee. Over the lifetime of a 10-year VC fund, this is worth about 20x (20% of 100x). The "venture capitalist" invests the remaining 80x into startups. Assuming they invest in 10 startups, each startup receives around 8x worth of money.

Let's break down the 600x return for institutional investors. This is the sum of the principal (100x) and typically 80% of the capital gains (500x). Simply put, we get the following algebraic expression:

## 500x = 80% x capital gains500x = 80% x (exit value - investment in startups)500x = 80% x (exit value - 80x)Solving for exit value -> exit value ≈ 550x

The "venture capitalist" has to earn about 550x return on 80x of investors' money. Assuming only 2 out of the 10 startups are successful, the return required on those 2 startups begin to look pretty ridiculous:

## 80x investment into 10 startups.Each startup receives about 8x investment.So the return required on those 2 successful startups is:550x / 16x ≈ 34 times return

That's hard to do.