Problem:
Suppose that 5 out of 10 investments made by a venture capital (VC) fund result in total loss, meaning that the return on each of them is -100%. And of the 10 investments, 3 break even, earning a 0% return. Assume that the fund managers require a 40% compound annual return on their investment and the risk-free rate is 6%.
a) What rate of return must the fund earn on the 2 most successful deals to achieve a portfolio return equal to expectations?
b) Assume that an entrepreneur is seeking a 10 million from this fund which thinks that the company is likely to be ready to go public in five years. At that time, the company is expected to have a value of â?¬450 million. What fraction of the company will the fund request in exchange for its investment? Assume that there will be no need for additional equity financing before the IPO.