Guest hellsten Posted September 6, 2014 Share Posted September 6, 2014 “WE HAVE MET THE ENEMY... AND HE IS US” Lessons from Twenty Years of the Kauffman Foundation’s Investments in Venture Capital Funds and The Triumph of Hope over Experience: http://www.kauffman.org/~/media/kauffman_org/research%20reports%20and%20covers/2012/05/we%20have%20met%20the%20enemy%20and%20he%20is%20us(1).pdf Venture capital (VC) has delivered poor returns for more than a decade. VC returns haven’t significantly outperformed the public market since the late 1990s, and, since 1997, less cash has been returned to investors than has been invested in VC. Speculation among industry insiders is that the VC model is broken, despite occasional high-profile successes like Groupon, Zynga, LinkedIn, and Facebook in recent years. The Kauffman Foundation investment team analyzed our twenty-year history of venture investing experience in nearly 100 VC funds with some of the most notable and exclusive partnership “brands” and concluded that the Limited Partner (LP) investment model is broken. Limited Partners—foundations, endowments, and state pension fund—invest too much capital in underperforming venture capital funds on frequently mis-aligned terms. Our research suggests that investors like us succumb time and again to narrative fallacies, a well-studied behavioral finance bias. We found in our own portfolio that: - Only twenty of 100 venture funds generated returns that beat a public-market equivalent by more than 3 percent annually, and half of those began investing prior to 1995. - The majority of funds—sixty-two out of 100—failed to exceed returns available from the public markets, after fees and carry were paid. - There is not consistent evidence of a J-curve in venture investing since 1997; the typical Kauffman Foundation venture fund reported peak internal rates of return (IRRs) and investment multiples early in a fund’s life (while still in the typical sixty-month investment period), followed by serial fundraising in month twenty-seven. - Only four of thirty venture capital funds with committed capital of more than $400 million delivered returns better than those available from a publicly traded small cap common stock index. - Of eighty-eight venture funds in our sample, sixty-six failed to deliver expected venture rates of return in the first twenty-seven months (prior to serial fundraises). The cumulative effect of fees, carry, and the uneven nature of venture investing ultimately left us with sixty-nine funds (78 percent) that did not achieve returns sufficient to reward us for patient, expensive, long- term investing. Investment committees and trustees should shoulder blame for the broken LP investment model, as they have created the conditions for the chronic misallocation of capital. Understanding the costs and long-term investment results of VC fund investing reveals still more nettlesome problems for investors: - The average VC fund fails to return investor capital after fees. - Many VC funds last longer than ten years—up to fifteen years or more. We have eight VC funds in our portfolio that are more than fifteen years old. - Investors are afraid to contest GP terms for fear of “rocking the boat” with General Partners who use scarcity and limited access as marketing strategies. - The typical GP commits only 1 percent of partner dollars to a new fund while LPs commit 99 percent. These economics insulate GPs from personal income effects of poor fund returns and encourages them to focus on generating short-term, high IRRs by “flipping” companies rather than committing to long-term, scale growth of a startup. The Kauffman Foundation’s approach to venture capital investing in the future will be to: - Invest in VC funds of less than $400 million with a history of consistently high public market equivalent (PME) performance, and in which GPs commit at least 5 percent of capital; - Invest directly in a small portfolio of new companies, without being saddled by high fees and carry; - Co-invest in later-round deals side-by-side with seasoned investors; - Move a portion of capital invested in VC into the public markets. There are not enough strong VC investors with above-market returns to absorb even our limited investment capital. Link to comment Share on other sites More sharing options...
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