The Math of VC Returns…

…or how important winners are to venture returns and how difficult it is to find them. Excerpts from a recent Seth Levine post (emphasis added):

Based on their data, a full 65% of financings fail to return 1x capital.  And perhaps more interestingly, only 4% produce a return of 10x or more and only 10% produce a return of 5x or more.

…This really underscores the challenge of creating a venture portfolio that produces reasonable returns. If you were to actually construct a portfolio based on these averages, a $100M venture fund investing in 20 companies would produce a gross return of approximately $206M (that’s before fees and expenses). The resulting fund would have an IRR in the range of 10% (the exact IRR would depend on the timing of the cash flows, but I constructed a few models to approximate this and 10% was the average return). That’s hardly something to write home about and underscores the challenge of being “average” in this industry.

Hidden in this exercise – and perhaps more important – is the challenge of finding companies at the right side of the distribution chart. In my hypothetical $100M fund with 20 investments, the total number of financings producing a return above 5x was 0.8 – producing almost $100M of proceeds. My theoretical fund actually didn’t find their purple unicorn, they found 4/5ths of that company. If they had missed it, they would have failed to return capital after fees. Even if we doubled the number of portfolio companies in the hypothetical portfolio, a full quarter of the fund’s return comes from the roughly ½ of a company they invested in that generated 10x or above. Had they missed it, they would have produced a return that roughly approximated investing in bonds – not the kind of risk adjusted return they or their investors were looking for.

…All of this math simply underscores how important winners are to venture returns and how difficult it is to find them.

Here’s the sobering chart that accompanied the post:

Related Posts: A very sobering and a humbling reminder..

Sobering. Very Sobering.

From Kauffman Foundation Bashes VCs For Poor Performance, Urges LPs To Take Charge

The Kauffman Foundation, which has ties to the venture industry, has issued a damning study of the business that addresses long-running concerns about poor performance..

…Looking into its portfolio of nearly 100 VC funds, including what it says are some of the most notable and exclusive names (confidentiality agreements barred it from naming them), the foundation found that only 20 of them beat a public-market equivalent by more than 3% annually, and half of those started investing before 1995.

…The report also offers support for the belief that small venture funds are the most successful. Only four of 30 VC funds in the foundation’s portfolio with more than $400 million in committed capital produced returns better than those from a publicly traded small-cap stock index fund.

…The foundation promises to take its own medicine. It said it will invest in venture funds of less than $400 million whose partners have consistently shown they can outperform public markets and who commit at least 5% of the fund’s capital. It also plans to do more direct investing to avoid paying management fees and sharing profits with VCs. And, it plans to shift money from venture capital to the public markets.