Return profile of VC investments shows why home runs are key

By October 25, 2012Exits

One of the world’s larger investors in venture capital recently shared data with us about the multiples they have made on over 5,000 companies they had stakes in via their LP investments in US VC funds. I’m not sure the extent to which they are happy with the information being made public so I’ve rounded the numbers and won’t mention their name. None of this alters the story which is that the data shows clearly why VCs want to make sure that every investment has home run potential.

This LP is one of the more successful ones, they have positions in many of the top funds and have achieved a very comendable IRR from their investments in venture funds (well north of 20%, which is great as an average). So think of the following as the profile of a successful fund rather than an average fund. Additionally, this analysis only looked at the companies which have exited, ignoring thousands of positions in companies that have yet to exit or go under. They said that they don’t believe this skews the data.

So, to the data.

The headline is that they received 60%+ of their returns from just 10% of their capital which was invested in companies that achieved home run exits of 5x or more. The average exit multiple in this homerun set was 16x.

This makes it very clear that unless a business can achieve a 5x+ exit, and maybe up to 16x+ then it isn’t likely to contribute meaningfully to the returns of a fund. Hence VCs target these sorts of exits on every deal.

Exceptional returns on the winners are, of course, necessary because of the large percentage of losers. In their sample 50%+ of capital was invested in companies that returned less than the original investment, and the vast majority of that 50% was invested in deals where all or nearly all the money was lost.

The remaining capital (nearly 40%) was invested in companies that achieved OK multiples of 1-5x. These accounted for 30%+ of the returns and are therefore an important part of the mix. Companies that achieve these kinds of returns are often in less sexy sectors (or sectors that didn’t turn out to be as sexy as everyone hoped) and can be harder to exit. Disciplined VCs work hard to make sure that they do find a home so they can get the capital back to their investors.

Remember that if these investors don’t make good returns then they will stop investing in VC funds and a large part of the startup ecosystem will grind to a halt.

  • Spot on Nic

  • Thanks Ben

  • It will help explain to young/1st time entrepreneurs why most (98% + ?) UK start ups will never see VC investment as they don’t really scale globally in the eyes of the VCs that dominate the top end of the game. It also shows how challenging it is for European VCs to get these type of multiples/exits and therefore returns. This seems to be a spiral down with less early stage VC investment in Europe as a consequence, but totally understandable from the numbers over the last 10 years. It certainly sorts the women/men from the girls/boys in who are really solving big tech/business issues that resonate and are able to compete globally. Nobody ever said it was going to be easy…… “when the going gets tough the tough get going”

  • JLP

    Thanks for article Nic however the conclusions are not nearly as interesting as the data. Would be quite interesting to show the data ploted on a graph perhaps with sector information as well to get a better idea of what is really going on. If they shared with you the data I am sure you can ask them if you can share the data points. Perhaps they could use one of their Big Data companies to help us visualize what is really happening here. That would be truly insightful.

  • I will look and see if there is any sector data when I’m back in the office. Not sure we’re going to get to the level of detail you describe.

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  • Dan Tomas Ishigaki

    Another dimension to this story is the size and stage of the fund. In theory all ventures should have home run potential but are required by VCs to sell up early, 3 or 4 years for their return. There are issues with rolling over to the next fund so that’s not an option and strategic sale may not be timely resulting in unrealized value. Not sure what the answers is here, something seems broken. Is VC to VC a possibility if it were a jump to a larger fund at an earlier stage?

  • VCs that invest in early stage businesses with little more than hope value seeking to private equity companies that invest in nature businesses with predictable profits is increasingly common, but the issue you describe is very real.

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