Lagging Indicators

Thomson Financial and the NVCA on Monday released their latest private equity performance numbers, and I’m trying to analyze them in the context of Sevin Rosen’s “VC model is severely damaged” argument.I see some validation for Steve Dow & Co., and also some contradiction (between Dow and the numbers, not between Dow and this company). Dow believes that VCs are blindly adhering to the following article of faith: Short-term ROI isn’t very good, but long-term investment in the VC asset class will outperform most major public indices. After all, some variation of that line has been in every Thomson/NVCA performance press release that I can remember (including today’s). So “stick with us,” the VCs tell their LPs, because “we’ll make you money in the end.”

The “blind” part is that such statements do not seem to acknowledge that the 10-year VC performance figures are around one year away from a harrowing fall. In fact, it may have already begun. 10-year horizon VC performance through Q2 2005 was 27.4%, then dropped to 22.7% at the end of Q1 2006 and currently stands at 20.8% (performance data lags by one quarter). Now imagine what will happen once the data begins to include all of the bubble-era Internet and telecom deals. We’ll be looking at brutal ten-year returns at least through 2009, and probably a bit longer. Dow’s basic point here is that the VC model isn’t nearly-damaged – it’s been damaged for quite some time, but the long-term numbers just have not yet reflected it.

But it also is noteworthy that the three-year and five-year VC performance data has begun to tick up a bit (discussing one-year returns is like discussing how a wine tastes one day after it’s been barreled). Dow would certainly counter that neither the latest three-year (9%) and five-year (-3.5%) VC returns are outperforming much of anything – and he’d be right – but the trend-line’s upward swing should be enough to at least instill some optimism that investors have learned from past mistakes. Perhaps it’s simply that the “too much money chasing too few deals” paradigm has become a bit less severe. Certainly possible. But it’s also worth considering that the real lagging indicator here is the recent upward swing, not the older downward one. (Note: Thomson Financial signs my paychecks, but I’m not involved in the data collection).