When taking on investment for your company—from family, friends, angels, VCs, PE firms, or even the public markets—it’s critical as an entrepreneur to understand what each group of investors expects from their money. Trust me, there’s a big difference between your mother’s $20,000 check and a VC’s $20 million investment. They are not the same.
A common misconception I hear when advising entrepreneurs is around the return expectations of venture capital. In this post, I’m going to break down how VCs think about returns so that before you raise money, you understand their expectations. I’ll write a separate post later about why those expectations matter so much—and how they can significantly decrease your chance of success as an entrepreneur—but that’s for another day. Subscribe to my Substack to get notified when I publish that.
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I’m going to use VC as the example throughout this post, but the same concept applies to professional angel investors as well, with one caveat. This math is only applied by serious angels—the ones who invest in 30–50 companies, treat it like a professional job, and make analytical decisions with their own or others’ capital. Your mom’s dentist investing as an “angel” in your company? He’s not thinking this way. He’s playing a completely different game.
The biggest misconception I see among entrepreneurs is simple: what return do VCs actually expect? Most founders think they know the answer—10X. If a VC puts in $1, they expect $10 back. If they invest $1 million, they want $10 million. You’ve heard this, right?
Here’s the disconnect: entrepreneurs don’t understand the power laws that govern VC returns. While you may think delivering a 10X return is a home run, what founders don’t realize—and what often shocks them—is that 10X barely moves the needle for a VC portfolio. In fact, it’s often just a “meh” result. I see this all the time: a founder I advise gets an acquisition offer that would deliver investors that mythical 10X. They’re thrilled, believing it’s an amazing exit. Then their board, now stacked with VCs, shoots it down as “not enough.” The founder is stunned. That deal would have been life-changing—generational wealth for them and their family—and the board says “no.” This is usually when I get the panicked call, and I have to walk them through VC math. Instead of whiteboarding this over and over, I’m explaining it here.
First thing to understand: VCs don’t invest in one company. They raise a “fund”—a set pool of capital from LPs (wealthy individuals, endowments, funds of funds, etc.)—and spread it across many startups. Depending on the fund size and strategy, that can mean 20 to 80 different investments.
Why so many? Because of the “power law.” In VC, a tiny handful of investments generate nearly all the returns, while the majority fail. Since no one actually has a magic eight ball (despite what some VCs might imply), they spread bets widely, hoping to back the next Uber, Airbnb, or Palantir.
Let’s do some simplified VC math.
Your company raises $1M at a $5M valuation. The VC fund that invests has $50M total, which it plans to spread evenly across 50 companies—$1M each. Entrepreneurs usually assume returns will look like this: 10% of the portfolio (5 companies) delivers 10X, the rest (45 companies) fail.
So 5 winners, 45 duds.
Each of those 5 winners returns $10M on a $1M investment. Great news for those founders: if they sold at a $50M valuation, and they still owned 80% of the company, that’s $40M in their pocket. Life-changing.
Now look at the VC’s math: they invested $50M across 50 companies. Five hit 10X, returning $10M each, for a total of $50M. They just broke even. After years of work, fees, and risk, their LPs got back less than $1 for every $1 invested. That’s why a 10X at the company level isn’t enough at the fund level.
This is when founders are floored. They brought investors a life-changing exit and got blocked. From the founder’s view, it makes no sense. From the VC’s perspective, it’s math.
Side note: if you’re ever in this situation, explore a secondary transaction. Sell a portion of your shares, take risk off the table, and keep building while the fund keeps holding out for a bigger exit. That’s a separate topic I’ll cover in another post, so subscribe if you want that breakdown.
Back to the math. If only 10% of companies return 10X, the fund overall is a poor investment. After fees, LPs would actually lose money.
So what happens if instead of 10X, those 5 winners return 100X? Now, each $1M investment turns into $100M. Five winners generate $500M total. Suddenly, the $50M fund has returned 10X to its LPs. Much better.
But remember, this takes time. Let’s say it takes 13 years (many funds run 12–14 years). That 10X over 13 years works out to an IRR of about 19%. Subtract management fees and carry, and you’re at ~17%. Over the last decade, the S&P 500 has averaged around 11–12% annually, so after all the risk and illiquidity, LPs are only earning about 5% more per year than they could in the stock market.
To be in the top quartile of VC performance, funds need ~25–30% IRR. In our hypothetical, that would require those 5 winning companies to return closer to **300X each** (not 450X). That’s already near impossible—which is why only a handful of funds ever reach that level.
More realistically, most funds end up with 1 or 2 truly outsized winners. For the math to work:
* If there are **2 winners** , each must return roughly **700X+**.
* If there’s only **1 winner** , it needs to return roughly **1,400X+.**
That means a company that raised at a $5M valuation might need to reach a $3.5–$7B valuation (and that’s before factoring in dilution from future rounds).
So hopefully now you see why, when you present investors with what feels like an incredible 10X return—a $50M valuation—it’s not enough. Not even close. They need billion-dollar outcomes to offset all their losses and outperform the stock market.
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