What gross multiple does the hurdle actually demand?
Fees take a fifth of the fund before a dollar is invested and the preferred return compounds for ten years. Model the portfolio the way it behaves, mostly zeros and a few winners, and the gross multiple the fund needs is a long way above the one in the deck.
Finance Advanced Monte Carlo Pro engine
After you install, this is the model to open.
Will the Fund Clear Its Hurdle?
- In your spreadsheet, click the Sortia icon in the strip of icons down the right-hand edge. No strip? Click the arrow at the bottom-right to open it. You can also use Extensions, then Sortia, then Open Sortia.
- Click Start from a template and put that name in the search box.
- Pick the card with that name and click Load this template. It arrives on a new tab with real numbers already in it.
This one runs on a Pro engine, and every free install includes five full-quality runs on your own numbers, shared across all five Pro engines rather than five for each. After that, Pro is $199/year.
The answer
- Clears the hurdle
- 41% of 20,000 fund lives beat the 8% preferred return
- What the hurdle demands
- 2.70x gross on invested capital, once fees take $5M of the $25M
- Median investor return
- 7.0% a year net; the P5 fund returns -1.2% a year
- Carry
- $0 in the median run; mean $1.4M, P95 $7.0M
A $25M fund with a 2% fee over ten years. That is $5,000,000 of fees, so only $20,000,000 ever reaches a company. The portfolio is modeled the way portfolios behave rather than the way spreadsheets do: half the companies return nothing, three in ten return the money, and the remaining fifth average 11 times. That is a gross multiple of 2.5 and $50,000,000 of proceeds, which sounds like a good fund.
It does not clear the hurdle. An 8% preferred return compounded over ten years turns $25,000,000 of commitments into a $53,973,125 bar, so a 2.5 times gross fund returns 2.0 times net, which is 7.18% a year, and the investors were promised 8%. Here is the number that should be on the first page of the model, and it is arithmetic rather than simulation: divide the hurdle value by the invested capital and the fund needs a gross multiple of 2.70 just to pay the preferred return, before a dollar of carry is earned.
Now click Run, with the two portfolio shares and the winners multiple on ranges. The net annual return to investors averages 6.46% with a median of 6.89%, and the clears the hurdle flag comes back at 0.40. In 60 of every 100 runs this fund misses the preferred return it was raised on. Carry, the third output, comes back at zero in 59 of every 100 runs, and its mean of about $1,382,000 is made entirely of the good two fifths.
A two and twenty headline hides the fact that the twenty is an option that expires worthless most of the time. The second run is the fee conversation, and it is worth having with numbers rather than with principles. Cut the management fee to 1.5% and rerun: invested capital rises to $21,250,000, the average net return rises from 6.46% to 7.06%, and the chance of clearing the hurdle rises from 0.40 to 0.46.
Fifty basis points of fee is worth about six points of hurdle probability, which is a real trade and a small one, and it tells you this fund is not going to be fixed by the fee. What this model cannot tell you: it has no timing. A fund that returns 2.5 times in year six and a fund that returns 2.5 times in year twelve are the same here and completely different to an investor, and the preferred return compounds through every extra year.
It also treats the winners as one average multiple rather than as one company carrying everything, which is a separate and sharper question. To make it yours, put your own committed capital, fee and life in, and set the three portfolio shares from the last fund you can get data on rather than from the one you are raising.
The model
It arrives on a tab called Template: Will the Fund Clear Its Hurdle:
| Committed capital ($) | 25000000 |
| Management fee, share of committed, per year | 0.02 |
| Fund life (years) | 10 |
| Total fees over the life of the fund ($) | 5,000,000 |
| Capital invested in companies ($) | 20,000,000 |
| Companies in the portfolio (count) | 22 |
| Share that return nothing | 0.5 |
| Share that return capital only | 0.3 |
| Share that are real winners | 0.2 |
| Average multiple on the winners | 11 |
| Gross multiple on invested capital | 2.5 |
| Gross proceeds ($) | 50,000,000 |
| Preferred return, per year | 0.08 |
| Hurdle value of committed capital at exit ($) | 53,973,124.9 |
plus 6 more rows on the sheet.
Once it is in your sheet
- The model arrives with real numbers in it and runs as it stands, so you can press the button first and understand it second.
- Change the numbers to yours. The sheet marks which cells are inputs and which hold formulas, and most labels carry a note explaining the row.
- Press the run button at the bottom of the panel. It is labeled for the tool you are in, and the result lands on its own tab, with a written reading of it beside the figures.
Never used Google Sheets? Start here goes the whole way, in seven steps, and assumes nothing.
Next question
- What does your target return cost you in risk?The Cheapest Way to Hit the Target Return
- Which fund risks are worth paying to cover?What Could Go Wrong in the Fund?
- Simulate five portfolio positions, each with a chance of not surviving the year and a value tied to the same funding market, to see the downside range. Free.What Does a Bad Year Look Like?
- Is that margin gap real or just a wider spread?Do Our Two Service Lines Earn the Same Margin?
- How much cash does a year need before it is safe, not just funded?How much cash gives 95% odds of not running out?
- Is your price a plan, or a coin toss against the margin target?What price keeps 80% odds of hitting the margin target?
Every model like this one, and the method behind them: Monte Carlo simulation.