Carey Ransom is a SaaS entrepreneur, executive, investor and advisor. He is president of Operate and managing director of BankTech Ventures, a strategic investment fund focused on compelling technologies for community banks—founded and funded by leaders in the community bank ecosystem.

There's an often undiscussed elephant in the room during most venture capital pitches: the return expectations that drive investment decisions. While founders may meticulously craft their growth projections and unit economics, they're usually a lot less clear on what potential investors actually need or want to see as a return rate hurdle. 

This mismatch isn't just a communication gap — it's a fundamental mathematical tension at the heart of venture capital.

The hidden math of venture returns

Most established companies evaluate internal projects against hurdle rates of 15% to 20% annual returns. These numbers reflect the cost of capital plus a risk premium, and they're often considered ambitious, but realistic, targets in traditional corporate finance. 

That all sounds reasonable, but here’s the problem. Venture capitalists typically target annual returns of 50% or more on their investments. This dramatic difference raises an important question: Can most business models realistically generate such outsized returns? (The answer is no. This is exceptional!)

Let's look at a concrete example. Consider a SaaS startup with $500,000 in annual recurring revenue (ARR) seeking to raise $3 million at a pre-money valuation between $8 million to $10 million. The founders are targeting 80% gross margins within four years but haven't yet reached that level. What would it take for investors to achieve a 50% annual return on their investment?

Running the numbers is sobering. At a $9 million pre-money valuation, investors would need the company to reach a value of roughly $61 million in four years to achieve their target return. Even with optimistic revenue multiples of 10 to 15 times ARR (common for high-growth SaaS companies), this means the company needs to grow its ARR to between $4million and 6 million in four years. That requires a compound annual growth rate of 70% to 87% — sustained over four years — while simultaneously improving gross margins to 80% and maintaining strong unit economics.

It may seem possible, but this doesn’t actually happen very often, and it gets even harder as the numbers get bigger. This also assumes outsized valuation at an exit of $5 million or more in ARR, which is less likely when the company is smaller. This mathematical reality underscores why traditional VC firms rely so heavily on the power law distribution of returns: the idea that a small number of massive winners will drive the majority of fund returns. When you plan for 50% or more returns across a portfolio, you're essentially counting on finding companies that can deliver multiples well above that to compensate for the inevitable failures and modest performers.

The founder reality gap

A deeper issue also exists with these mathematical challenges: Many founders aren't sufficiently grounded in the realities of valuation and return on investment math. This isn't necessarily their fault: Most entrepreneurs excel at product development, customer understanding, and market innovation rather than financial modeling. However, this knowledge gap can lead to misaligned expectations and potentially harmful strategic decisions.

When founders don't fully grasp the return requirements driving investor decisions, they might:

• Think they’re doing great while their investor only sees underperformance;

• Push for higher valuations without understanding the future growth and ROI implications for them and their business;

• Pursue growth strategies that aren't sustainable for their business model;

• Miss opportunities to align incentives between themselves and investors; or

• Make operational decisions that optimize for the wrong metrics.

Improving the conversation

Both investors and founders could benefit from more transparent discussions about return expectations and their implications. Here are several ways I think this dialogue could be improved:

1. Share return models openly: VCs should be willing to walk founders through their return requirements, analysis and goals and what that means for company growth targets. This doesn't mean every company needs to hit these numbers, but understanding them helps inform conversations and strategic decisions.

2. Focus on multiple paths to success: Instead of fixating on a single growth trajectory, discuss various scenarios and gates along the journey that could deliver acceptable returns. This might include different combinations of growth rates, margins, and exit horizons and multiples.

3. Align on metrics that matter: Establish clear agreement on which operational metrics best indicate progress toward mutual goals. This helps ensure that day-to-day decisions align with long-term value creation.

4. Regular expectation check-ins: Build regular discussions about return expectations and progress into board meetings and investor updates, allowing for course corrections when needed.

The BankTech Ventures model

When we launched BankTech Ventures, we recognized that the traditional VC math often wouldn't work for our specific market and investor base. Our limited partners are banks that were also planning to be regular customers and partners of our portfolio companies. This dual role (investor and business partner) created a fundamentally different dynamic, prompting us to review our approach to return expectations and portfolio construction.

Instead of relying on power law returns, we've built our strategy around achieving more predictable, private equity-like performance from a larger percentage of our portfolio companies, even as an earlier stage investor. This approach also aligns better with our investors' needs for business durability, continuity and reliability in their technology partners.

Our portfolio companies still need to deliver strong business results, growth and returns, but we're not counting on finding unicorns to make our model work. Evidence shows that $1 billion exits are extremely rare in banking technology, so “proper capitalization” is usually a better approach than following traditional venture funding models. Our focus and discipline allow us to concentrate on businesses with solid fundamentals and clear paths to profitability, rather than betting on the slim chance of finding the next generational company.

We’re certainly happy to help founders build those outliers, preferring they discover outsized value and scale over time, rather than swinging for the fences in search of a home run or strikeout, with nothing in between.

The broader implications

This experience suggests that there might be room in the venture capital ecosystem for more diverse approaches to return expectations and portfolio construction. While the traditional VC model works well for certain types of companies, markets and fund sizes — particularly in software and technology — other sectors and business models might benefit from different approaches to early-stage investment. As we've seen in the aftermath of the most recent VC bubble and burst, many funds and companies will be left broken, causing others to rethink and consider reinvention.

We believe — and have seen — that the key is aligning investment strategy and return expectations with the realities of your market, the needs of your investors, and the characteristics of the companies you're backing. Sometimes, a more balanced portfolio of solid performers is more valuable than a collection of moonshots with a few stars. 

Our early returns are also demonstrating that this can work.

For founders, an understanding of these dynamics can help them choose the right capital partner. The important question isn’t just whether you can raise money, but whether your business model and growth trajectory align with your investors' needs and expectations.. Sometimes, the highest-profile VC firm might not be the best fit for your company's path to success.