Venture Capital - Thoughts On The Asset Class
I wrote a post a week or so ago thinking outloud about what a good "venture return' is. Yesterday, one of our investors, Lindel Eakman of UTIMCO, stopped by this blog and left a very interesting comment on that post.
Lindel pointed out that UTIMCO's portfolio return on all VC funds over the past 10 years was in the range of 9pcnt and that he thought that wasn't very good. He did point out that VC is well ahead of the public equity markets in their portfolio and so to the extent they have their equity dollars in VC (or other private equity), that is better than public equity right now.
The punch line to Lindel's comment is important. He wonders if VC can't do better than 9pcnt across a diversified portfolio, would UTIMCO simply be better in bonds given the illiquidity and greater risk of the VC asset class?
And sadly, it may well come to that. VC has not proven that it can scale as an asset class since the mid 90s. The vast amount of money that has come into the sector from public pension funds in the past fifteen to twenty years has not been put to work very well and returns for the asset class as a whole have come down. It may well be the case that the public pension money (and other money) may leave the asset class as CIOs and the investment committees ask the hard questions that Lindel is asking.
Peter Parker, a long time VC and entrepreneur, replied to Lindel with the observation that a downsizing of the VC business would be a good thing for the LPs that remain because the best firms in the business are doing very well and are generating returns well above the 9pcnt which may well be the average performance for most investors in the VC asset class over the past 10 years.
I note that the industry returns I posted on this blog a month or two ago show a 10 year average return of 17.3pcnt so UTIMCO's portfolio is in theory below the average, but those 10 year returns are heavily influenced by the late 90s internet bubble and also the phenomenal returns delivered by KP and Sequoia on their Google investment. I would not be surprised to see that 9-10pcnt returns are the average for funds that did not take advantage of either of those big return generators.
Many will argue that this is not good news for entrepreneurs. And that may well be true. But I think entrepreneurs in the web sector have done a great job of figuring out how to build companies on much lower capital needs and we also have a vibrant angel and early stage (pre-VC) market developing. So it may be that the real problem is that there is simply too much money looking to get put to work in the VC asset class (certainly that is true in information technology) and that as money starts to leave the sector, we'll have a smaller and healthier VC business to operate in.
I don't know what this means for biotech and cleantech and it may well be that those sectors can handle larger sums of venture capital and still generate acceptable returns. I'll leave it to those who know something about them to comment.