Everyone raising a venture fund will tell you they plan to 3x your money, at least. But it turns out, almost no one can do it.
David Clark of Vencap International ran an analysis on nearly 1,200 funds covered by Pitchbook. Most haven’t even returned 2x their invested capital, much less 3x.
Clark’s Analysis
Clark’s analysis looked at funds from 2000 to 2015. Any fund from 2011 or earlier should’ve exited its investments by now, so I wouldn’t expect them to show higher returns in the future.
Some of the newer funds are still holding investments that haven’t gone public yet. This may increase their returns somewhat, but performance is likely to remain middling.
What Performance Should We Expect?
I cannot stress enough how abysmal this performance is.
A median return below 2x is far worse than you’d see in stock index funds! The S&P 500 has averaged a 10% annual return since 1957.
In 10 years, that gives you a 2.6x return on your money. And that is with total liquidity at all times.
Moreover, your money is in big, blue chip companies. That’s a lot safer than fledgling startups.
Under no circumstances should you accept a lower return than that in illiquid, speculative companies. Investing in venture only makes sense if you can make 15% a year, minimum — or a 4x fund over 10 years.
Why Does Venture Have Such Rotten Returns?
The problem in venture is supply and demand.
VC assets under management are growing at 20% a year. Meanwhile, there are still only so many great startups.
Too much money is chasing too few good companies. Especially at the later stages when winners are becoming apparent, this leads to inflated prices and poor returns.
Fat wallets also make investors lazy.
Why not rip $10 million into a crypto company with no product? We’ve got billions to play with!
What Kind of Funds Win?
A few funds still produce amazing performance. Susa Ventures I is one such fund:
The fund was small, making it easier to run up a big multiple. It’s a lot easier to get to 5x if that means you have to produce tens or hundreds of millions in returns, rather than billions.
Each year, there are only so many big exits to go around. You don’t want to have to be in a decacorn in every fund just to get a decent return.
What Does This Mean for Me?
My “fund” is microscopic. That makes it much easier to get a big return, since I don’t need a monster exit to make it happen.
If I take the money I have earmarked for the first 3-4 years investing (a typical fund life), I only need a single exit of about $2.5 billion to hit that 15% a year benchmark. The rest of the portfolio could go to zero.
Hitting a unicorn isn’t easy, but since I’ll be making around 36 investments in that period, I think it’s feasible.
What’s more, I invest much earlier than most VC funds. That gets me into deals at low prices with a lot of upside.
Wrap-Up
Anyone considering investing in a VC fund should be extremely selective.
Look for smaller funds with strong track records. And carefully consider whether you need to be in this asset class at all.
Those boring index funds perform surprisingly well!
What do you think of VC performance? Leave a comment and let us know!
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