How does risk/return work?

That’s a lot of talk about “probability of success of a startup”.

Sounds all very interesting, but how does that work, really?

Spreadsheet time!



You are an investor.

You decide to invest in 10 startups.

You want to make a 15.0% internal rate of return (IRR) on your portfolio.

You have a 5-year investment horizon.

So you want to make a 2.0x money multiple (MM) on your portfolio.

That means the portfolio must have a $2,011 exit value on a $1,000 post-money valuation.

For each startup

Based on the number of milestones till their exit and the probability of success for each milestone, you invest in 10 startups, each with a 30% probability of success.

That’s the same as saying that 3 out of 10 startups in your portfolio will succeed. The other 7 will fail.

Failure means an exit value of $0.

Because the portfolio must have a $2,011 exit value and only 3 startups succeed, each startup you invest in must have a $670 exit value.

A $670 exit value on a $100 post-money valuation means you must invest in a startup at a 6.7x money multiple or 46.3% internal rate of return.

Some investor remarks

Given this logic I have a hard time understanding the following investor remarks.

“There is still so much uncertainty in your startup.”

It is an early-stage startup, so it does have a low probability of success. But that is discounted in the money multiple at which you discount our exit value.

“We would rather invest in the next round.”

That means at a higher probability of success than the current round, so at a lower money multiple. It will not make a difference to the internal rate of return of your portfolio.

Hesitant: “Your startup is very risky so we need a very high internal rate of return?”

True. We are early stage, so we have a low probability of success.

What does Warren say?

Am I pulling this logic about risk/return and startup valuation out of thin air?

Not necessarily.

Let’s hear it from my personal hero, Warren Buffett:

“If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually independent commitments. Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities. [..] Should you choose to pursue this course, you should adopt the outlook of the casino that owns a roulette wheel, which will want to see lots of action because it is favored by probabilities, but will refuse to accept a single, huge bet.”

True that.


Thanks to Hans Westerhof and Chretien Herben.

Joachim Blazer is a corporate finance advisor. He helps founders raise money. Contact him at