The LP’s Playbook For Evaluating VC Fund Returns & Risk

This article is part of our 10-part series, Insider Secrets: What LPs Must Know to Invest in VC Funds in India, where we decode key insights for navigating this asset class with confidence.

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For Limited Partners (LPs), evaluating the performance of a venture capital (VC)  fund is crucial for assessing whether their investments align with expected returns,  risk levels, and strategic goals.

This chapter explores key performance metrics,  benchmarking strategies, and best practices for assessing a fund’s long-term viability and success.

Key Performance Metrics For VC Funds 

Unlike traditional asset classes, venture capital relies on distinct performance indicators. LPs must understand these key metrics to accurately evaluate a fund’s success and compare it with industry benchmarks. 

Internal Rate Of Return (IRR) 

• Definition: Measures the annualized return on invested capital over time,  considering cash flows and the time value of money. 
• Why It Matters: IRR is a critical benchmark for assessing fund efficiency,  especially in early-stage investing where cash flows are inconsistent.
• Best Practice: Compare IRR against similar funds and prevailing market conditions to ensure alignment with risk expectations. 

Multiple On Invested Capital (MOIC) 

• Definition: Represents the total value generated from investments relative to the amount invested (e.g., 3x MOIC means an investor tripled their capital). 
• Why It Matters: MOIC provides a straightforward evaluation of fund success,  particularly when comparing early-stage and late-stage VC funds.
• Best Practice: Consider MOIC alongside IRR for a complete picture, as  MOIC does not account for time value.

Distributions To Paid-In Capital (DPI) 

• Definition: Measures the capital returned to LPs relative to the total amount invested. 
• Why It Matters High DPI signals strong fund liquidity and actualized returns rather than just paper gains. 
• Best Practice: A fund with a high IRR but low DPI may indicate unrealised gains, requiring deeper due diligence. 

Residual Value To Paid-In Capital (RVPI) 

• Definition: Measures unrealized portfolio value relative to invested capital.
• Why It Matters: Provides insight into remaining portfolio upside potential.
• Best Practice: LPs should analyze RVPI trends and compare them to DPI to assess overall fund maturity.

Benchmarking Fund Performance Against Industry Standards 

VC fund performance does not exist in a vacuum; LPs must compare fund results against relevant industry benchmarks to understand relative success. 

Key Benchmarking Strategies 

• Compare Performance Against Peer Funds
  • Review fund IRR, MOIC, and DPI against funds with similar vintages,  strategies, and geographies.
  • Use independent industry reports (e.g., Cambridge Associates,  PitchBook) for standardized benchmarking.
• Assess Performance Relative to Public Market Equivalents (PME)
  • PME analysis compares a VC fund’s performance against public equity indices (e.g., S&P 500) to determine whether VC investing is outperforming traditional markets.
  • This helps LPs assess whether the illiquidity premium of VC investing justifies the additional risk.
• Analyse Fund Performance Across Vintage Years
  • Evaluate how different fund cohorts (vintage years) perform relative to industry cycles and macroeconomic conditions.
  • Strong performance across multiple vintage years indicates consistency and resilience.

Best Practices For LPs In Evaluating Fund Performance 

While many VC funds operate with integrity, LPs must be vigilant about governance failures that can jeopardize their investments. Some of the most  common governance red flags include: 

• Monitor Performance Periodically 
  • LPs should track fund performance quarterly or annually to assess changes in valuation, distributions, and unrealized gains. 
  • Regular monitoring allows for proactive decision-making rather than reactive assessments. 
• Evaluate Portfolio Company Performance 
  • Beyond fund-level metrics, LPs should assess individual portfolio companies’ financial health, revenue growth, and market positioning.
  • Fund success is ultimately driven by the quality and scalability of portfolio investments. 
• Engage with GPs for Transparency 
  • LPs should maintain an active dialogue with fund managers to understand valuation methodologies, expected liquidity events, and market conditions. 
  • Transparent reporting structures ensure LPs have a clear understanding of fund trajectory. 
• Assess Exit Strategies and Liquidity Planning 
  • Strong fund performance is tied to successful exit strategies (IPOs, M&As,  secondary sales).
  • LPs should evaluate how well a fund executes its liquidity events and returns capital to investors.

Conclusion & Key Takeaways 

1. Using Strong Governance is Essential: IRR, MOIC, and DPI Are Key Metrics – LPs must use a combination of these metrics to assess fund success beyond just paper gains. 
2. Benchmarking is Critical: Comparing fund performance against peers and public markets ensures realistic evaluations. 
3. Ongoing Monitoring is Essential: Regular performance tracking,  engagement with GPs, and exit strategy assessments help LPs optimize returns.

This article is co-authored by Anup Jain & Rajeev Suri, Founder Partners @ BlueGreen Ventures