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 founder at Venture Value. Contact him at

Venture Value does startup valuations for founders who want to raise money with an investor.