I had a conversation with a startup founder about the returns investors expect when investing in startups. The general rule of thumb that many founders have heard is 10x. Investors want a 10x return on their money. They put in $1; they ideally want to receive $10.

What that rule of thumb doesn’t consider is time. When an investor puts money into a startup that doesn’t have product-market fit, he’s usually expecting to hold that investment for 7–10 years. It takes that long to find product-market fit and scale the business to a material size that would make it an acquisition target.

So, the 10x rule of thumb is really saying that investors want a 10x return over 7–10 years.

Investors have lots of options. They can buy stocks, bonds, etc. But the performance of those other asset classes is usually measured annually. The 10x rule measures performance over multiple years. So, how would an investment that returns 10x compare to the annual performance of other asset classes? Good question. To do that comparison, you need to convert that 10x into an annual rate of return.

Let’s do the conversion. For simplicity’s sake, let’s assume an investment in an early-stage startup is held for 10 years and generates a 10x return. When you do the math, it equates to a compound annual growth rate (CAGR) of 25.89%. That means the investment grew at an annualized rate of ~26% over the 10-year holding period.

So, the 10x rule is really saying that investors want a ~26% annual compounded return on an early-stage startup investment (assuming a 10-year holding period). That’s considerably higher than the ~12% annualized return (including dividends) of the S&P 500 over the last 50 years.