The J-curve and patience

What the first statements look like

In the first years of a fund, money goes out and nothing comes back. Fees are charged, companies are bought at cost, and a few of them fail quickly while the winners have not yet been revalued. Plot the fund’s value against time and you get a curve that dips below zero before it rises. That dip is the J-curve, and it is the single most common reason first-time LPs panic.

Nothing is wrong. This is what year two of a healthy fund looks like.

When the curve turns

Values start to move when portfolio companies raise new rounds at higher prices. That usually begins in years two to four. Actual cash distributions come later, when companies are acquired or go public, typically in the second half of the fund’s life. Many funds return most of their cash in years seven through twelve. If a GP tells you to expect distributions in year three, ask why.

The three numbers

Every quarterly report leans on the same measures:

• TVPI, total value to paid-in capital: the current value of everything, distributed and still held, divided by what you have paid in. Above 1.0 means the fund is worth more than it has cost so far.
• DPI, distributions to paid-in capital: cash actually returned divided by what you have paid in. This is the number that matters in the end, and it stays near zero for years.
• IRR, internal rate of return: an annualized figure that accounts for the timing of cash flows. It is useful for comparing funds of the same age and misleading for anything else, since a small early exit can produce a huge IRR that means nothing.

Early in a fund’s life, TVPI depends on the GP’s valuation choices. Ask how they mark companies and whether an outside administrator or auditor reviews the marks.

Patience as a strategy

The people who do well as LPs treat a fund commitment as a decision they make once and then stop revisiting. They read the letters, ask questions, and otherwise leave it alone for a decade. The people who struggle try to judge a fund in year three. If you are not comfortable not knowing for a long time, venture is the wrong place for that money.

Before you move on

If a fund reports 1.4x TVPI and 0.1x DPI in year four, what do you know and what do you not know?