What Is The Total Value To Paid-In Investment Multiple?

As a startup founder raising capital for your company, you should pay attention to the Total Value to Paid-In multiple. Startup investors use the Total Value to Paid-In (TVPI) capital metric to evaluate their fund’s performance. Both venture capitalists and private equity firms calculate this metric as a ratio.

From the entrepreneur’s perspective, you’ll calculate the expected returns delivered to investors. Also called the investment multiple, this ratio is the sum total of the realized profits and unrealized future profits. If this metric is 1.00x, it indicates that the investment broke even in terms of value.

Anything less than 1.00x means that the investors have lost money. When approaching investors for further funding rounds, you should demonstrate that current investors have earned a higher than 1.00x ratio. The higher the ratio, the more profitable the company is.

That’s how you can convince them of the viability of your company as an investment option.

What is the Total Value to Paid-In Multiple (TVPI)?

To understand how investors think, it’s crucial you understand how VCs and PE firms are structured. Investors pooling money into a venture capital or private equity firm are essentially limited partners. They cannot withdraw their holdings at any time but invest with the expectation of future returns.

By calculating the TVPI, investors estimate the profits they have made relative to the initial capital they invested. They also use the IRR (internal rate of return) to measure the fund’s success and financial performance.

As mentioned earlier, the TVPI combines realized and unrealized profits. Realized profits are the returns or capital investors, and limited partners have received from the fund as distributions. These distributions include interest or dividends earned from the investments.

A significant chunk of the distributions results from the fund liquidating its holding in one or more of its portfolio companies. For instance, when the company is acquired or goes through an IPO. Or, when the fund sells the equity in its portfolio companies in the secondary market.

Unrealized profits are the potential profits the fund can earn from its residual holdings. The fund calculates this estimate according to its preferred valuation method.

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How to Calculate the TVPI?

Total Value to Paid-In = Total Value / Paid-In Capital

Here, the total value is the sum total of the cumulative distributions or realized profits. That is, after the fund deducts management fees, overheads, and other expenses. The total value also includes the residual or estimated value of the investments the fund still holds. Or, the unrealized returns, also called net asset value.

This figure is divided by the Paid-in Capital or the total amount the investor has contributed to the fund. It’s crucial to note that the paid-in capital is the money the investor has already added to the fund. It does not include the money the investor may have committed to contributing.

When an investor joins the venture capitalist or private equity firm as a limited partner, they sign a subscription agreement. Accordingly, they commit to contributing a specific sum of money through the fund’s investment period. This money is called a capital contribution.

Each new contribution during the fund’s investment period increases the limited partner’s paid-in capital. Typically, the general partner (GP) or the fund manager, calls for a fresh infusion of capital.

Let’s try an example. Fund A has a TVPI of 1.50x, and Fund B has a TVPI of 0.75x. This metric shows that the investor or limited partner earned realized distributions worth $1.5 for every $1 they invested. This means that their investment appreciated in value.

However, since Fund B has a TVPI of 0.75x, it shows that the investor earned just $0.75 for every $1 they invested. That’s a loss of $0.25. Note that the earnings are typically an average of the returns from all the holdings the fund has invested in.

Advantages of Calculating the Investment Multiple

The Total Value to Paid-In multiple is a simple and straightforward technique to estimate how the fund is performing. Investors can also use IRR (internal rate of return), but this method is more complex. Further, manipulating TVPI numbers is challenging, but it makes them more reliable.

Other advantages include:

• The figures used to calculate TVPI are easy to compile and compute, and the results are simple to interpret.
• The general partner provides the TVPI according to industry benchmarks and indicates the investment’s absolute value. Investors can compare the figure to other competing funds of similar size, age, and scope to gauge performance.
• Investors and fund managers prefer to use the total value to the paid-in ratio to estimate if they have positive returns.
• The TVPI technique includes realized and unrealized holdings, making assessing the GP’s investment acumen easy. Limited partners can evaluate if the GP is proficient in identifying viable companies for investing. Further, it indicates if the GP can make strategic exits at the right time for maximum returns.
• Investors can calculate the TVPI at any time in the fund’s lifecycle to evaluate its aggregate performance.
• The TVPI is not subject to different interpretations and assumptions as in the case of the internal rate of returns.
• Non-professional and novice investors with little or no experience can track their portfolio’s performance without the need to consult experts.
• Investors can use the TVPI to time their exit. Investors maintain their holdings if the TVPI is higher than 1.00x and growing consistently. But, if it starts to drop, it may be a good time to exit and sell their equity.

Downsides of the Total Value to Paid-In Ratio

Although the TVPI is easy to compute and interpret, it has its share of downsides. Here’s what all investors need to know:

• The TVPI does not factor in the time value of the invested capital. For instance, a TVPI of 3.00x at the 5-year mark would indicate that the investor tripled their investment in 5 years. However, if the TVPI remains consistent at the 10-year mark, it would indicate similar returns. This means that the investor tripled their investment in 10 years, which is not the same. Thus, the TVPI does not account for interest rates within the time frame. Nor does it calculate the timing when the investments and distributions were made. From the investor’s perspective, all these factors influence the returns they earn at the end of the fund’s cycle.
• The total value to paid-in (TVPI) includes unrealized or residual holdings in its calculations. The value of these assets can change drastically by the time the GP liquidates them. Investors may not receive expected distributions because of evolving macroeconomic conditions or other factors. The end ratio may not indicate an accurate return rate if a significant portion of the TVPI comprises unrealized holdings.
• When calculating distributions or realized returns, investors must remember to factor in the fees and overhead costs. Overlooking them can result in an inflated TVPI, which may not give an accurate performance estimate.
• TVPI only calculates the returns the company has delivered or can potentially deliver. However, it does not account for the potential risks. Even if the fund has invested in high-risk companies, the TVPI will continue to remain high.
  

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Workarounds for an Accurate TVPI

Investors can use different workarounds to ensure a fair and accurate estimate of the fund’s performance. Here are some of the factors to consider.

• When adding the total asset value, investors must compare the realized distributions against the unrealized holdings.
• The specific time in the fund’s lifecycle can influence its TVPI. For instance, the TVPI will likely be low in the fund’s initial years when the investments are new. Further, the GP may not have entirely invested the fund’s capital and is yet to build an investment portfolio.
• The TVPI is reliant on the valuation methods the GP may use to assess the fund’s holdings. The limited partners may have their own techniques for valuing the portfolio companies.
• Accurately valuing portfolio holdings can be challenging year after year because of different variables. For instance, inconsistent cash flows and macroeconomic conditions influence valuations across the sector. Estimating TVPI during economic downtrends may not generate reliable figures.
• Investors typically diversify their risk by diverting capital to different funds. Comparing the TVPI of different funds over a similar timeframe or in similar industries can deliver a more accurate estimate. At the same time, in the case of disruptive sectors, there may be very competitors investors can use for analysis.
• The TVPI depends on the growth stages of the companies in the investment portfolio. For instance, if the fund has invested in early-stage companies, the returns are likely to be lower. However, investing in growth-stage or later-stage companies will likely yield higher returns and, thus, higher TVPI. This is why, in-depth due diligence is crucial when evaluating companies.

 

The TVPI and IRR are only a few of the metrics investors calculate. If you need more information about what startup investors look for in entrepreneurs before investing, check out this video.

TVPI vs. IRR – From the Startup Investor Perspective

Investors evaluate startups based on two metrics–the total value to paid-in (TVPI) and IRR or Internal Rate of Return. The TVPI demonstrates the value they have received for their investment in the company. This is the total of the distributions you delivered by way of interest and dividends.

Investors will factor in not only the initial investment they made in your company. But also the additional investment they can potentially make during follow-on funding rounds.

But, when investors calculate the IRR, they estimate the rate of return their investment has generated year after year. Essentially, it is the percentage of return on investment they expect to receive over their investment term.

These are the metrics investors will be looking at when evaluating your startup as a viable option. When you approach them with a pitch, you’ll design it to address their concerns and demonstrate that the metrics are positive. That’s how you can convince them to participate in further funding rounds.

Not only do investors use these metrics to evaluate your startup, but they also use them to compare different opportunities. Expect that they will do a side-by-side comparison to evaluate the risks and returns before selecting the right option. Remember that their objective is higher returns with low risk.

As long as the TVPI and IRR are high, investors will retain their holdings in the company. However, it is also understandable that these numbers will likely be low in the company’s initial stages. But, as it stabilizes, the metrics are likely to increase.

A good example is Uber. In 2014, the company had a total value to paid-in of 4.6x and an IRR of 102%. Another example is Airbnb, which demonstrated a TVPI of 3.8x and IRR of 130% in 2015.

The Takeaway!

Investors work with key metrics like the total value to paid-in (TVPI) multiple to estimate how the fund is performing. If the fund consistently demonstrates multiples higher than 1.00X, that’s a good investment option and yields good returns.

But if the multiple goes below 1.00x, it may be a good time to exit. Investors participating in venture capital and private equity firms as limited partners use these metrics to ensure good returns. In the startup funding context, they use the TVPI and IRR to estimate if a startup is worth backing.

They’ll use the numbers and compare them against industry benchmarks and similar companies to evaluate performance. As a startup founder, you should learn to leverage these metrics to enhance your pitch and entice investors.

Understand how investors think and evaluate startups and give them what they need to interest them in backing your company.

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