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Family offices evaluating venture capital as LPs have to understand how quantitative dynamics is crucial to making informed allocations.
VC offers a range of “products” to investors, from small, new, and emerging funds to large, established firms. Each product type can be a valuable vehicle depending on investment style and expectation, there is no universally superior approach, only different strategies to suit diverse goals. Smaller fund sizes, in particular, have shown a correlation with higher potential returns, but it is important to recognize that such funds also experience greater variability, wider return dispersion, and more noise due to limited performance track record and lack of observability of return consistency across vintages.
Let’s understand how fund size and ownership drive venture capital returns, with an illustration.
Smaller funds, such as a $10M seed fund, operate with comparatively modest tickets, for example, allocating $300,000 per company as a follower (not lead). These smaller checks can deliver meaningful ownership at entry (in the sample, 4%). Conversely, a much larger $1B fund must write proportionally larger tickets (e.g., $3.5M) to maintain relevance and portfolio construction, aiming for higher entry ownership (in this scenario, 14%), for instance as a lead.
Both small and large funds face similar cumulative dilution over the company’s lifecycle (here, 50% dilution at exit). The combination of initial ownership and dilution results in a final position at exit (2% for the smaller fund, 7% for the larger). When a strong exit occurs ($1.5B in this illustration), the exit proceeds for each fund are dramatically impacted by these percentages.
The smaller fund’s $300k check returning $30M generates a 100x gross multiple on the deal and represents a 3x return relative to the entire $10M fund. The large fund, despite securing a larger absolute exit value ($105M), achieves a gross deal multiple of 30x but a mere 0.11x multiple versus the overall $1B fund size.
Smaller funds benefit from outsized returns when a single major exit can move the needle, the economics allow one investment to return multiples of the entire fund. Larger funds require truly extraordinary outcomes (much greater than $1.5B), or many substantial exits, to match this impact at the fund level.
For S/MFOs considering VC allocations, fund size, ticket size, and ownership dynamically interact to set the ceiling on returns. Ideally, S/MFOs develop a VC portfolio construction embracing the barbell dynamics of this asset class.
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