Is venture capital broken? Worse, is it dead? Unfortunately, there’s no getting around the fact the overall venture returns for the past decade are uninspiring. But when have overall venture returns not been dismal? The median vintage year return over the past 29 years averages a mere 8%, which is hardly worth the effort. In fact, the ten-year pooled mean for venture went negative as of the end of 2009, and many investors concluded that it was indeed the end of venture.
So why should anyone be optimistic about the future of venture capital now? First and foremost, because inventors keep inventing but need help commercializing their innovation. Venture capitalists provide a unique skill-set to make this happen. VCs need money, and limited partners are willing to provide it. This is a virtuous circle of value creation: Capital from LPs and expertise from VCs transform entrepreneurs’ ideas into game-changing products and services building companies with real value. Sounds like Venture Capital 101, but too many investors have lost track of this model’s potential for success.
Second, there is a select group of experienced and visionary VCs that continues to support innovation with proven skills. As in poker, success in investing comes from taking educated bets under situations of uncertainty. All investors bet on the future—fixed income investors bet on the direction of interest rates, public markets investors bet on future earnings growth or relative value, hedge funds bet on any number of things. But none has control over the next card dealt. This is where experienced VCs have the advantage. They take the hand dealt and are then able to switch out some cards—tweak the strategy, change sales channel, improve management, etc.—to have a better chance at winning.
Third, there are lots of cards to play. Innovation is creating more areas of opportunity than ever before in information technologies, health care and now clean tech, each with many subsectors. Which will succeed? No one can know for sure, but successful VCs not only add value, they also have developed a vision for the future to guide their investment decisions.
Informed by the past, we invest in the future. The key for LPs is to be selective and patient. Venture capital is not for the faint of heart or those who can’t manage with some illiquidity because building value takes time. But invention never has a recession. Technology continues to evolve at a rapid pace, and entrepreneurs continue to actively start new companies and seek the most experienced VCs to help fund and build them.
Index returns for venture never have been, and never will be, worth the risk and illiquidity of the sector. But there should always be great returns for those few VCs who consistently make visionary, educated, valued-added bets on innovation. The average top-quartile break point in those same 29 years is 21%. For the past ten vintage years, the pooled mean for all top-quartile funds is already 9% (including those still in their j-curve phase). In a slow growth economy with volatile public markets and low interest rates, top-quartile venture capital should outperform other asset classes. Why? because venture capital—that virtuous circle—is the only investment opportunity that creates something out of virtually nothing. Selective and patient LPs will reap the rewards! .
Georganne Perkins is a managing director in the San Mateo office of Fisher Lynch Capital, which manages some $2 billion through funds of funds and co-investment funds. Previously she had been director of private equity at Stanford Management Company. Reach her at firstname.lastname@example.org