Why Venture Capitalists Need Those Big Returns

In the world of early-stage investing, you’ll often hear venture capitalists talk about seeking “10x or 50x returns” or “fund returners.” Occasionally, you’ll hear the claim that “our fund requires every investment to have the potential to return the fund on its own”. For founders raising capital, understanding these ambitious expectations is vital. Let’s break down why VCs need these outsized returns and how this investment class differs from others.

 

The Math Behind Venture Returns

When a VC firm considers investing in your startup, they’re looking at the investment through a very specific lens.

For a typical early-stage investment with a 7-10-year exit (commonly via acquisition or IPO) horizon, VC often target a minimum Internal Rate of Return (IRR) of around 30%. This value represents the asset’s ability to generate positive cash value over time. It must be a large value as the cash return needs to outperform far less risky investment methods such as term deposits, corporate bonds or managed funds. In practical terms, an investor requires a significant multiple on their return, linked to the length of time the capital is invested, i.e. for an investment into a company with a:

• 7-year exit timeframe a ~7x minimum return on invested capital or a;
• 10-year exit timeframe a ~14x minimum return on cumulative invested capital is expected.

VCs often cannot accurately predict when they will exit an investment so will often target an average return e.g. a 10x Multiple On Invested Capital (MOIC).

But where do these numbers come from?

 

Breaking Down the Return Requirements

It’s not greed—it’s math.

The target return isn’t arbitrary. It’s justified by the risks associated with this asset compared to more traditional investments – the ‘upside’ must be bigger for early-stage VC investments to justify the risk profile. In a typical venture portfolio:

• 40-50% of investments return nothing (complete write-offs)
• 30-40% return between 0-2x (modest outcomes)
• 10-20% drive the majority of fund returns

Therefore, when modelling the required return on investment the modelling is built on several layers of risk premiums. Common examples include:

• Base Rate (Risk-Free Cash): Currently around 5% This is essentially what investors could earn by putting money in safe government bonds.
• Illiquidity Premium: 3-4% Unlike public shares or stocks that can be sold instantly, startup investments lock up capital for years as investors typically only get their money back through exit of the company (sale or IPO) or possibly through another investor buying their equity in a later fundraising round (often referred to as selling ‘secondaries’).
• New Technology Premium: 4-5% companies that require new technology to be developed for the business to succeed carry extra risk.
• Venture Risk Premium: 15-20% This accounts for the high failure rate in startups i.e. the reality that many investments will return zero. Industry data shows that around 65-75% of venture investments return 0-1x capital.

When you add these components together, you get a required return of 27-34% IRR. Other key risk premiums are often added to investments depending on the technology and market sector the company operates within. For example, some biotech companies have a higher risk profile because of the high rate of failure inherent in developing drugs and therefore, they carry other risk premiums including technology risk, regulatory risk etc.

 

Why This Matters for Australian Founders

Understanding these expectations helps you position your startup appropriately. If you’re raising venture capital, investors will be applying similar math to evaluate your investment opportunity.

This doesn’t mean every company needs to be a potential unicorn[1], but it does mean your growth narrative and exit timelines need to align with these return thresholds. A business with modest growth potential might be wildly successful by normal standards but may not be a fit for traditional VC funding.

 

VC vs Other Asset Classes

This is where is the expected IRR for venture capital differs dramatically from other investments:

• Public Equities: Target 7-10% annual returns with daily liquidity
• Real Estate: Typically aims for 8-12% IRR annual returns with moderate liquidity
• Private Equity: Seeks 20-25% IRR with moderate risk profiles
• Venture Capital: Requires 30%+ IRR with high failure rates

Another key difference is the portfolio approach. While real estate investors expect most properties to appreciate, and private equity investors expect most acquisitions to ultimately succeed, venture capitalists know that many of their investments will fail completely. The outsized successes must compensate for these losses. VC investment is commonly discussed as being a slave to the ‘Power Law’, whereby most of the capital returns from a portfolio are generated by a select few companies.

 

Breaking Down a 10x Return

If a VC invests $5 million for a 20% stake in your company, a 10x return means the VC needs to realise $50 million from that stake at exit. Working backward, this means your company needs to exit at a valuation of approximately $250 million, depending on how many additional diluting events (e.g. fundraising) take place.

 

What Does It Take to Achieve a 10x Exit?

For a VC to realise a 10x return, a startup is likely to have to:

• Grow revenue by 50–100x from the initial investment.
• Reach a $500M–$1B+ valuation (if the VC owns 10% at exit).
• Successfully scale and dominate its market.

Understanding these return requirements helps founders in several ways:

• Market Size Matters: Your addressable market needs to be large enough to support an outcome that delivers these multiples.
• Exit Strategy: VCs are looking for a clear path to liquidity, typically through acquisition or IPO.
• Funding Alignment: If your business model is unlikely to deliver these multiples, traditional VC might not be the right funding source.

 

Final Thoughts

For Australian entrepreneurs, this framework helps explain why VCs ask tough questions about market size, scalability, and competitive advantage. They’re not being deliberately difficult – they’re assessing whether your venture can potentially deliver the returns their business model requires.

If your business doesn’t fit this profile, that doesn’t mean it’s not valuable or worth building. Many successful companies are funded through alternative means better suited to their growth trajectory e.g. ‘bootstrapping’. Understanding the VC model helps you determine if it’s the right funding path for your specific venture. In addition, knowing what VC are looking for helps you design your pitch in a way that addresses key questions up front and means that your opportunity is more likely to progress to more detailed consideration.

 

If have a startup that you think can generate Venture Capital returns and have a strong link to the University of Queensland. Please contact us through the UEF website or email us at investment@uniquest.com.au 

 

[1] A somewhat arbitrary definition of a company that is valued at $1B or more.