Of unhatched chickens and VC returns

In the world of VC, the savvy never count their chickens till they are hatched. Or calculate returns till you have moolah in the coolah. But others are more than glad to do it for them. They count your unhatched eggs and rank chicken farmers based on their “unhatched” chicken count. But wait, you ask — how can you do that? Those chickens have not hatched yet. And therein lies the conundrum of measuring VC returns.

So why do we even measure what’s un-necessary, even inane? Well, someone benefits from selling the data. Or creating news. The media business thrives on headlines — if it bleeds, it leads.

When CNN — 24 hour news channel was launched, some journalists bemoaned that sensationalism and entertainment will trump relevance, depth, and quality of interpretation. A “journalism of assertion,” is starting to eclipse the more traditional “journalism of verification”. Journalism of “assertion” does not question if a claim is valid. Rather, it throws it out for discussion. Speed matters and “let’s get this out there first” can trump the logic and validity of content.

The recent Wall Street Journal news “Andreessen Horowitz returns trail venture capital elite” (paywall) compares A16Z’s returns to Sequoia, Benchmark, Founders Fund and concludes that A16Z “ hasn’t yet earned its reputation as an elite firm.” Such a news report falls in the category of sensationalism as opposed to verification.

Those of us in the business know that the reputation of a VC firm is measured by the two sides of the equation — attracting quality entrepreneurs and attracting LPs. A VC firm is no different from a marketplace in that regard. If you look at A16Z’s fund size and 5X growth in three years, not many VC firms have been able to replicate such growth. Check that box on attracting LPs.

A16Z Fund Size and returns

And any entrepreneur would take money willingly from A16Z. Not just because they overpay (as in agree to higher valuations) but the way A16Z’s entire team can serve the founders. These are ground facts that most of us in the business know. Unlike IRR, reputation of a firm cannot be measured crisply on a spreadsheet.

A16Z responded saying that WSJ misses the “mark” as it’s too early to call the results. Dan Primack ‘s “Term Sheet” (a must read PE/VC column in Fortune magazine) ran a deeper analysis of the data. Mark Suster of Upfront Ventures shared his views concluding that A16Z is building a durable brand with an enviable emphasis on serving the founder.

Lets look at A16Z’s unrealized value. As much as 68% to 86% of the fund value is still on paper. This can change the final score by orders of magnitude. If residual value is high, we should not count these chickens yet. Nor should we declare winners.

A16Z funds unrealized value ranges from ~38% to 86%

So what’s an elite newspaper like WSJ to do? Do nothing till 2019, or till the fund is fully liquidated.

In the following graph, Pitchbook data shows how VC fund distribution is function of time. Distributions occur after as much as 10+ years from launch. IMHO, VC industry data needs to be measured / compared once the funds are fully liquidated. Then and only then we know for sure who leads the pack.

Simplifying those acronyms:

  • DPI = Distributed to Paid in Capital — Amount paid out to investors / LPs.
  • RVPI = Residual Value to Paid in Capital— Value of equity yet to be liquidated / paid out
  • TVPI = Total Value to Paid in Multiple — Add DPI and RVPI and this is what you get.

The global 2012 VC vintage has distributed only a median 0.03X of the Paid in Capital. Rest of the capital has just been invested, or some may yet to be called. As in, its sitting with investors. So why do we even measure data / returns when we know the game has just begun?

Counting chickens before they are hatched is silly. But starting to compare my unhatched chickens with yours and then declaring winners is even sillier. It’s short term speculation, sensationalism and creating news when there is none.