Remember what we said earlier? Research says that 3 out of 4 startups fail. Which means investing in startups is extremely risky. So, if you’re betting money in this risky asset class, you’d expect high rewards also, right? That’s why, experts suggest that you should expect at least 10% alpha (additional returns) on your startup portfolio, over and above the market benchmark index (like NIFTY50) coming to around 25%. To corroborate this, we analyzed the investment portfolios of 10 notable Angel investors of India, comprising of 500+ startup investments. At an average, their investment grew by 30% p.a. Combining the 2, you can target an IRR range of 25% - 30% on your startup investment portfolio.
Alright, so there’s high risk, high reward and long gestation period. How do you factor all these and have a benchmark to work with? Let’s do some math:
Considering the expected ROI from your entire portfolio of startup investments @25% - 30% and the failure rate of startups @3/4th, we calculated your expected IRR from each startup investment – which comes to 52% - 84%, depending on the investment horizon. This range is also corroborated from a study published by KPMG in 2021, which collates IRR expectation of investors from early-stage investments by 4 different research papers. It suggests a broad IRR range of 50% to 100% in seed stage investments.
Now there’s 1 more thing to consider: For you to achieve your targeted IRR, the startup’s valuation will have to grow even more, because of the dilution in your stake over subsequent funding rounds. Let’s understand this with an e.g. – say you invest ₹40 Lakhs ($50K) in a startup at a valuation of ₹4 Crore ($500K) getting 10% stakes in the venture. Over the next 5 years, the startup dilutes 75% of its shares in subsequent fundraises up to its Series C funding in which it's valued at ₹100 Crore ($12.5M). So, at the end of the Series C round you hold only 2.5% of the company. Therefore, even though the venture’s valuation grew 25x from when you invested, your MOIC (multiple on invested capital) is only 6.25x (i.e. an IRR of 44%). You get the gist right?
Long story short, our calculations indicate that a startup’s valuation shall multiply by at least 25x to 76x over the investment period (longer the investment period, higher the multiple) for you to earn the targeted IRR of 52% - 84%.
To sum it up, if you’re creating a portfolio of 4 startup investments with an investment horizon of say 7 years, you’re holding good if at least 1 of them have grown in valuation by 76x over the next 7 years.
We’ve summarized below our findings of targeted IRR and minimum growth required in startup’s valuation to achieve the overall ROI of 30% p.a. on a portfolio of 8 startup investments of equal amounts, assuming 75% of them give zero returns:
Find answers to other questions relating to Angel investing in India:
This article is a part of the Jun'24 edition of our Startup Newsletter. Here's the complete publication:
