As a venture capitalist, I worry about the future of our industry. Too much money, high valuations, and no exit markets are just a few of the structural problems to worry about. But, at least we’re better than that bastion of capitalism — the stock market.
The latest data is out on Venture Capital performance through March 31, 2009. Rather than detail every performance number, think of it this way. If you had invested $10,000 every year since 1999 in the average venture capital firm, you would have converted your total investment of $100,000 into just $85,000 (after paying the VC partners for their expertise). Yes, you just lost money.
Well, let’s say you know the best venture capitalists and you know how to “stock pick” your way towards the future winning firms. Your portfolio of investments would have been all the top quartile firms — the best performers. In that case, you could have turned your $100,000 into $121,400. Better, but that’s not even 2% return per year. That’s worse than inflation.
Your alternative, of course, is the stock market. If you had put $10,000 each year into the NASDAQ or the Dow Jones Industrial Average, you’d have $69,700 or $72,000 of your $100,000 remaining, respectively. That’s even worse than the venture capital returns.
(Note that for expert observers I’ve ignored some timing details of IRR calculations and the fact that recent venture funds haven’t had a chance to “ripen”. These results are still consistent through various assumptions, including looking at the venture returns just up through 2005.)
So what would the stock markets have to be to make you indifferent between the markets and venture capital? If the NASDAQ reaches 1850 or the DJIA reaches 9,000, a stock market investor would equal an investor in average venture funds. Those are believable attainments, and the stock markets are way more liquid (you can buy and sell whenever you want or need to. That’s an advantage).
But to reach top quartile venture returns, the NASDAQ needs to find 2650 and the DJIA needs 12,850. Those aren’t historically impossible, but they seem a bit far from where we are today (currently NASDAQ is at 1730 and the DJIA is 8418).
While I’m clearly biased in favor of venture capital, the simple fact that I can compare VC to the stock markets doesn’t bode particularly well. VC is an illiquid investment and it’s riskier, with higher variations than the broad stock market. For that, venture capitalists have to provide a premium. Over the 40 years ending in 1998, that premium was about 6% per year higher returns than the stock market. That means your $100,000 would have to be worth $148,500 dollars today — something not even the top quartile firms have provided.
Sean Foote's Blog 