In the VC method, required ROIs represent the minimum returns investors look for when funding a startup. They depend on the average returns of their portfolios.
Investors expect the majority of their portfolio companies to return less than the invested amount, so their final result will come from just a small, high-yield fraction of the companies.
If investors were to accept a deal with an expected return below the average, the few successful startups might just not pay off enough to cover the losses.
How Equidam determines the required ROIs
Equidam's ROI calculations are based on first principles of venture capital economics. The approach considers three fundamental factors:
Dilution Impact: Account for ownership dilution that occurs through subsequent funding rounds (using data from Carta). As companies raise additional capital, existing investors experience dilution that must be factored into return expectations.
Time Value Consideration: Convert target returns into annualized rates based on expected time to exit (using data from Stanford), recognizing that earlier-stage investments typically have longer time horizons to exit than later-stage investments.
This methodology ensures that required returns are calibrated to both the fund's overall performance targets and the specific risk profile of the company at its current development stage. As companies progress through stages, their success probabilities increase, leading to lower required returns that reflect the reduced risk profile.
The Stage Progression
Stage | Fund Multiple | Success Rate | Target Multiple | Retention | Multiple / Retention | Required ROI |
Idea | 5.0 | 5.94% | 84.25× | 0.42 | 201.31× | 94.08% |
Development | 5.0 | 10.23% | 48.88× | 0.52 | 93.43× | 76.32% |
Startup | 4.0 | 15.76% | 25.38× | 0.7 | 36.49× | 56.77% |
Expansion | 4.0 | 21.77% | 18.37× | 0.76 | 24.20× | 48.93% |
Growth | 3.0 | 32.62% | 9.20× | 0.84 | 10.96× | 34.89% |
This progression demonstrates how both risk (reflected in success rates) and future dilution (reflected in retention rates) dramatically impact the returns investors need to target at different stages.
Example
Investors focused on Idea stage startups are expected to produce an aggregate return across their whole fund of 5x. However, they also expect:
A low success rate (5.94%) of their investments, reflecting early stage risks.
Their ownership will be heavily diluted (58%) by the time their investments exit.
Thus, the value of a startup they invested in must grow by 5.0 ÷ 0.0594 = 84.25× to account for the probability of success, and then 84.25 ÷ 0.42 = 201.31× to account for dilution.
If a company must grows in value by 201.32X over 8 years, the typical time to exit, then the required ROI is 94.08%.