|
ROI (Return on
Investment) is the premium an
investor receives for investing in a company when he liquidates his
holdings. Private equity investors express their return expectations
in terms of percentages, much the same way lenders price their
loans. By determining what compounded annual rate of return he wants
from a given investment, an equity investor can then work with his
projections for the company’s growth to arrive at the percentage of
the company’s stock he needs to receive in order to reach his
desired return.
What ROIs do most venture capitalists
require to fund a company? They vary from company to company. The
following chart gives some general ranges, based on an economy
supporting prime interest rates below 10 percent.
|
Company Stage |
Compounded Annual ROI
|
|
Seed or
start-up |
35% and
up |
|
First and
second stage |
20% to
50% |
|
Third
stage and mezzanine |
15% to
30% |
How these rates of return translate
into cost to a company depends in large part on how long it takes
the investor to exit. The following table illustrates this fact.
|
Payoff |
Compounded
Annual ROI |
|
Three times investment in
three years |
44% |
|
Five times investment in
three years |
71% |
|
Seven times investment in
three years |
91% |
|
Four times investment in
four years |
41% |
|
Three times investment in
five years |
25% |
|
Five times investment in
five years |
38% |
|
Seven times investment in
five years |
47% |
|
Ten times investment in five
years |
58% |
See Pricing, Procrastination,
Projections. |
