The return profile of investing in an SMB acquisition also varies widely from the VC asset class—in terms of structure, type, and consistency.

In venture capital, the potential investment returns are commensurate with the risk at each stage of a startup’s life. For this reason, investors in early-stage startups target significant power law returns because the risk of a shutdown is so high at the earliest stage.

Early-stage VC investors may benchmark their target returns as much as 100x multiple on invested cash (MOIC) or 35%+ internal rate of return (IRR). As startups mature, their relative risk of shutdown tends to decrease, and as a result, investor return expectations also decrease. A late-stage startup investor may target 1.5-5x MOIC or 20% IRR.

Investment returns in SMB acquisitions are different for two reasons:

Risk profile
Investor distributions.

Each SMB acquisition will have different financial projections, but it’s common to see issuers projecting a 3-4x+ MOIC on a 5-year exit and 25-35%+ IRR. These expectations are lower than those of early-stage VC deals because the risk of investing in this asset class is much lower. However, SMB return expectations are typically greater than late-stage venture capital.

Compare this to venture capital, where a 3x MOIC on a fund is very good—reportedly, only 10% of VC funds achieve it.

As a reminder, SMB acquisitions typically occur in tenured companies with years of profitable operating experience and proven systems in place. SMB investors usually receive a waterfall return structure that prioritizes their return on investment and a preferred investor return. These deals can do so because of their available free cash flow. This stands in contrast to VC deals, where companies often do not distribute cash and only realize investor returns—based on seniority, multiple, and participation—when there is an exit opportunity.

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