“I am only an average man but, by George, I work harder at it than the average man.” – Theodore Roosevelt
Ok, I know the holiday season has come and gone, and there is a lot to be thankful for, but it seems as if there should way more venture investors doing some soul searching this season. When it comes to returning capital to investors, let’s be honest, realized returns in venture capital have not been nearly good enough for way too long.
While over the last year unrealized returns are close to 30% for VC funds, longer terms returns are mediocre at best and realized returns are just plain depressing. VC returns have underperformed public equities by almost 5% per year over the last 5 years and barely beat public equities over a 10 year period (not even factoring in the illiquidity of venture investments).
When you look at actual returns though it is even worse, and if you are an average performer, it simply is not good enough. After 10+ years of bad results for funds, the industry cannot sustain the existing ecosystem. You cannot be average, ordinary or just another fund to survive.
While there have been some nice upper quartile results that have propped up venture returns over the last couple of years (mostly driven by unrealized gains), the average fund has returned almost nothing from recent investments. Since 2011, the average fund has returned less than 5 cents on every dollar. I know it is early, but 5%? Shouldn’t we be able to do better as an asset class?
To make maters even worse, there has only been one year since 1999 (yep 15 years) where the average fund has returned more than it has invested. As for that one year (2003) it has now returned… get ready for it… 1.07 times your money. Shall we start grabbing dollar bills and join Mitt? Lets do this!
When you dig further, the 3x returns (that we are all told VC’s are going after) are just a pipedream for most funds. While a lot of folks are doing quite well from ever-growing fees; carry, which should drive performance-based compensation, is only available for the very best funds. If you end up being an average fund, then good luck. Tell a good story to LPs, lean on friends and raise as much as you can, because the fees you generate are all you are likely to see for a very long time.
Even the current macro economic environment is against outsized returns — we are living in a world where the risk free rate is well under 3% and public equity returns going forward should be closer 6-7% per year. We should not expect historic returns of 10-11% going forward (10.43% from 1960-2012) and venture returns should be in line with these expectations. Due to these lower returns system wide, the 3x+ return for VC funds will only be there for the VERY best. The bar is so much higher than people think, and if you don’t acknowledge it, you are kidding yourself. Even if you double the market return (say 14%... which would be amazing) it would still take you 9+ years to earn a 3x return.
While there has been a clear paradigm shift in venture, it is still tough for a lot of people to acknowledge (especially when you benefit from a high returns world). At Lightbank, we invest our own money, thus we cannot afford to fool ourselves. As a fund we are thrilled with the results we have generated since we launched in 2010, but we are also realistic about what attributes distinguish us as investors. We are making changes to the way we invest. Some areas have worked incredibly well, and we are doubling down our efforts there. While others have been simply average and we are adapting our strategies.
Our vision is to be one of the best, and most unique, investors in growing technology companies, and our pledge is to be true to who we are and what we do best. After 88 investments in three years, our formula stands out — investing our own money behind exceptional entrepreneurs in spaces where we can add value based on our own experiences of growing businesses — the results have been exceptional, and we’re very proud. At the same time, we are learning as we go, and finding more ways to tap into our deepest strengths, to better align to entrepreneurs and industries where our uniqueness can provide the greatest leverage and results. Many things we thought about ourselves were dead on, while others were a little surprising. One thing we know for sure — we will never stop evolving as investors, because the cost of being just another fund is simply too high.