venture-capitalSo, I run my own share portfolio and have learnt a fews thing about the return of capital for various financial instruments but the cost of capital in the startup world seems quite detached from bond yields and equity risk premia.
Let me propose a simple model. A VC wants 20% rate of return from a basket of 5 investments in startups. In this simple model each startup has the same level of profitability and same probability of success (unreal but this simplifies the math). Each startup has a 1 in 5 chance of success, so the statistical expectation is 1 startup succeeding. Because the money has been split 5 ways, the successful startup must carry the burden for the rest of the portfolio, so the VC must charge each startup a cost of capital of 100% to get to the portfolio target of 20%.
So is 100% cost of capital valid in this model (or have I made a mistake)? Is this model reflective of the costs of capital observable in startups today?
[100% seems quite high when 10 year treasuries are at 2.38% and equity risk premium is ~4%]
[Why is ‘cost of capital’ not a tag on this site?]
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