Towards a Risk Model for Venture Capital Funds: Liquidity and Performance Forecasting

Abstract

We propose a conceptually clear and consistent risk management tool for both performance and liquidity forecasting for venture capital funds. Its input is a factor on market conditions and a correction factor that is a judgment on the accuracy of the reported net asset value as the net present value of the fund. Our methodology is useful on a fund and fund-of-funds level. To summarize our work, the interim internal rate of return is the most common performance measure for a venture capital fund and is computed from the past cashflows and the reported net asset value, the proxy of the value of the remaining investments. Future repayments are often independently modeled for liquidity planning by using a distribution scheme with a growth rate. However, we show that the generated future repayments are, in general, not consistent with the interim internal rate of return unless a constraint is satisfied. This is the case, because the net asset value contains aggregated information from the future cashflows. We prove that, for a simple distribution scheme, this constraint is satisfied when its growth rate equals the interim internal rate of return. Thus, the growth rate is fixed by consistency and the distribution scheme has only one free parameter, the distribution function.

Keywords: venture capital fund, risk, model, modeling, modelling, cashflow projection, IRR, net asset value, fund-of-fund, risk management, tool

JEL Classification: C0, C53, G24