I read an article recently that exclaimed that returns in the fourth quarter of 2013 for venture capital had exceeded equivalent returns from the public markets which hasn't happened very often since the internet bubble burst. After reading the article, I felt that it missed the mark on venture returns, so here are some of my thoughts:
- Venture capital returns should be measured over long terms. Venture Capital is a long-term asset class, so the focus should be on long-term returns. Most venture capital funds have a headline 10 year life (some are moving to 12 years) with two to three years in extensions, but the reality is that most funds take a lot longer to fully wind-down - 15-18 years in my experience. Thus, the returns that I focus on are the 10 and 15 year returns.
- Venture returns should exceed public market returns. Venture capital (1) is a risky investment, (2) is an illiquid investment (generally speaking), and (3) has a long-term holding period (if held to maturity). As a result, venture capital should provide a premium to public markets. What should the return premium be? In my experience, investors in venture capital limited partnerships (known as Limited Partners or LPs) look to have a premium of 300 basis points to 700 basis points (or more) over a public market index. I lean to the 500 basis points premium. What public market index should be used? In my view, the Russell 2000 or Nasdaq seem to be the most logical indices but I know many LPs that use the S&P 500 or other indices.
- Venture returns are unique to the investor. While venture capital indices are interesting for high level analysis and showing industry trends, these indices can't be replicated by an investor and so each investor's experience will be different. The vast majority of venture capital funds are private vehicles that have a limited number of investors. Some funds are very selective as to their investors, for example, some funds have excluded public pension funds as investors because of freedom of information act issues. The general public also can't typically invest in venture capital funds as most funds are limited to wealthy investors (accredited investors) who are invited to invest by the fund managers.
