Navigating the venture capital landscape requires a robust knowledge of self-evaluation tactics. Kruze is here to steer you in the right direction — and ensure your business stays on top of its future success. The ratio of distributions to paid-in capital (DPI) is one of many financial formulas that instills confidence in your team and investors; here’s how to use it best.
DPI measures the total capital that a venture capital fund has returned to its investors (excluding items like management fees*). Paid-in capital is the amount received from selling stock shares to investors. The distributions to paid-in capital are calculated by dividing the cumulative distributions by the amount of capital invested in a VC fund.
Distributions to paid-in capital allow private equity fund managers to measure the performance of their investments. This kind of metric in private equity reporting is also known as the realization multiple. A DPI of 1 means that investors got back the same amount of money they paid into the fund. Anything over 1 indicates profit for the investors.
*Management fees are the charges taken from capital investors as a percentage of the committed capital. These fees are deducted from distribution prior to calculating gross DPI but are included in your net DPI. We’ll go over how to calculate both later on.
WHY THE DISTRIBUTIONS TO PAID-IN CAPITAL IS IMPORTANT
There are plenty of ways to gauge the health and progress of your startup. But, at the end of the day, you want proven performance, the kind of concrete results that instill confidence in your limited partners.
In the current private equity investment climate, many high-valuation startups leave the impression of high profitability (as noted in their venture capital funds’ books). These high valuations show some impressive returns on paper, but that doesn’t reflect the reality of distributing actual cash to limited partners, which is preferable.
A higher DPI shows how a fund can successfully deliver cash back to private equity investors, which, in turn, can influence future investments in the fund’s portfolio companies. VCs and PE firms need to eventually make a return for their investors, meaning they have to realize investments and then distribute that capital back to their investors.
Returning cash to investors also helps investors make subsequent allocations to the fund, as this cash flow can be reallocated to the firm’s next fund.
What is the DPI ratio?
The distributed-to-paid-in ratio tells you exactly how much money has come back to the investors, which is important for determining how real the venture capital fund's returns are. Sometimes, when the valuations are too high on some of their startups, a VC fund actually can’t raise money. Some of those companies are going to fail and it will be a pretty big hit to the fund’s returns.
Go and check out our video on startups with too high a valuation to learn more about overvalued startups and why they will need to reset.
DPI formulas
There are two common formulas to calculate DPI: a gross and a net formula.
Gross DPI formula
Gross DPI measures the total capital that could flow back to investors, excluding management fees and fund expenses. It’s calculated by:
Gross DPI = Total Distributions to LPs / Total Capital Paid-in
This metric provides a good view of the total possible distributions relative to the total capital called, without considering the impact of fees.
Net DPI formula
Net DPI, on the other hand, measures the actual capital returned to investors (taking into account the impact of management fees, carried interest, and other fund expenses). It is calculated as:
Net DPI = (Total Distributions to LPs - Total Fees and Expenses) / Total Capital Paid-in
Net DPI is particularly relevant to LPs who want clarity about the effect of fees on overall returns, and who want to know how much cash their investment is producing relative to the amount they’ve invested.
DPI IN REGARDS TO A PRIVATE EQUITY FUND VERSUS A VENTURE CAPITAL FUND
While venture capital funds and private equity funds are invested in private companies, venture capital funds focus on early-stage startups. Both are considered a private equity investment, but a private equity fund is typically invested in an established company (to optimize profitability). A venture capital fund is a form of private equity fund that goes after riskier investments for higher returns.
Beyond the risk profile and investment stage, there is also a distinct difference in control between private equity funds and venture capital funds. Private equity firms often obtain a controlling interest [this is when the shareholder(s) own enough of a company’s shares to influence or control policy and management].
That’s essentially how private equity funds work; to gain a controlling interest, increase a private company’s value, and then sell for profit. Venture capital funds, however, will generally acquire a minority stake in a company. This is a common strategy used to diversify an investment portfolio (but still participate in the growth potential of a company).
DPI is relevant to both private equity funds and venture capital funds: LPs in both instances rely on DPI to assess the performance and liquidity of a fund. It also reflects how much money they’ve made from their investment.
So why does the difference between the two matter so much when it comes to DPI? Because DPI is an extremely important metric for VC funds. It’s critical in assessing fund performance compared to unrealized gains, which heavily fluctuate in an early-stage startup.
For VC funds, the distributed-to-paid-in ratio is essential. Ideally, it should be as high as possible. Investors hope for a return multiple, such as five times the initial investment. In the early days of the fund, however, the ratio is going to be a very low number, which can climb based on the number of successful startup exits.
The difference between MOIC and DPI in private equity
Multiple on invested capital (MOIC) is also used to measure investment performance; it represents the gross returns of funds to invested capital. The key difference between DPI and MOIC is in the numerator: multiple-on-invested capital includes both realized and unrealized value in the numerator, whereas the distributed-to-paid-in ratio only includes realized value.
Residual value to paid-in capital (RVPI)
Residual value to paid-in capital (RVPI) offers a multiple of capital paid in by investors (the current total value of assets held by the fund). RVPI is useful for tracking the progress of funds relative to the initial investment (and how much value the fund still has to offer after distributions).
Distributed-to-paid-in capital ratio can be combined with RVPI to assess the total value to paid-in capital (TVPI) of the fund. The residual value will change each quarter after the funds are valued, and the RVPI will shrink as capital is distributed to investors.
DISTRIBUTIONS ARE INDISPUTABLE
Cash is king! As a limited partner investor, the focus of private equity investments is the distributions from a private equity fund. This is the cash that has been returned (not including the residual value), which can be used to fund the next commitments of that venture capital fund.
Many funds have been raising new rounds every couple of years instead of every four or five years. By providing cash to their limited partners with more regularity, they encourage investors to recommit. And this strategy can yield fruitful results.
THE DPI RATIO IS A CRITICAL METRIC
Don’t sleep on DPI! The distributed-to-paid-in equity ratio is a metric of great interest to the limited partner community — which makes sense because rather than the overarching paid-in capital, DPI represents the cash return that investors have received from a fund. This can be used to gauge fund performance.
If you have any other questions on venture capital ratios, valuations, startup investing, startup accounting, taxes, or venture capital, please contact us.
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