Understanding Venture Returns
A disappointing article in today's San Jose Mercury news reported on CalPERS releasing the results of its venture investment portfolio. The story obscures the nature of venture fund structure all the while proclaiming to be serving the "public good" but never seeming to take a stand either way on the subject at hand.
Venture investors raise a fund which is structured as (typically) a 10 year limited partnership. For the first few years, the fund invests in early stage companies and except in rare cases, it is a period where money only goes out in the form of investment (and fees to support the VC's day-to-day expenses). Funds always have a negative return during this period, in good times or bad. A look at the list released by CalPERS shows negative returns on almost all funds raised in the last three years.
Further compounding the problem, investments held by VC funds are subject to partnership accounting treatment and don't get marked to market every day (like a mutual fund). Until venture investments become liquid through an IPO or M&A event, they are typically valued based on the post-money valuation of the last money raised. So a company like Google, which raised one round of investment capital in the late 90's, would still likely be held on the books at that valuation -- clearly not reflective of today's value.
Investors in venture funds understand all of this: they typically have long-term investment horizons and aren't looking for short-term liquidity or returns. Typical venture investors like school endowments, pension funds and foundations build investment programs over decades and measure their venture investments over the life of the fund, not the first few years.
The disappointing part of the article is that the reporter doesn't try to explain any of this, even though CalPERS does. Instead the article reads like yet another "bash the VC" piece. There is plenty that went wrong with the venture industry over the last few years. But negative returns in the early years of venture funds is just par for the course.
Categories
The Economy & Finance1 TrackBacks
Listed below are links to blogs that reference this entry: Understanding Venture Returns.
TrackBack URL for this entry: http://ventureblog.com/cgi-bin/mt/mt-tb.cgi/49
VentureBlog: Understanding Venture Returns - The first few years of a venture fund will generally have a negative return...... Read More
Very good posting. The author of this article is not the only one ignoring the key characteristics and mechanics of the venture capital investment cycle. I am currently working on my Ph.D. on a venture capital related topic, and I can assure you that even very many academics have not understood the cash flow and return patterns of venture capital funds. They regularly conduct empirical studies on VC fund performance where they include non-mature funds that had their closing only two or three years ago - clearly, any such performance figure is pretty much meaningless.