Rethinking The Return Myth in VC

Cambridge Associates recently released a phenomenal study that anyone who follows the industry should read. The study examines the commonly held belief that the majority of returns within the VC industry are driven by only a small percentage of deals and that only the top quartile of funds produce the necessary returns for investors. The study concludes that while the returns in the industry are driven by a limited number of investments, that number is larger than previously thought and growing.

You can find it here but if you don’t want to take the time to read it, here are some of my favorite takeaways.

· In the post-1999 (i.e., post-bubble) period, the majority of the value creation in the top 100 each year has, on average, been generated by deals outside the top 10 deals;

· Prior to 2000, the top 10 deals accounted on average for 57% of value creation. Since then, the top 10 deals accounted on average for 40% of value creation

· The composition of the firms participating in this level of value creation has changed, with new and emerging firms consistently accounting for 40%–70% of the value creation in the top 100 over the past 10 years.

In other words, the best VC Firms still do extraordinarily well but new and emerging funds have a better chance of succeeding than ever before. And we have seen this take place with the success of new funds such as Andreessen Horowitz, First Round Capital, Lowercase Capital, Homebrew and many others, all of which are relatively new firms. So why is that? I think there are a few good reasons:

1. There is greater geographic diversity among startups in today’s market. Silicon Valley is still the center of the venture universe, but the lower cost of starting a company and increased ease of getting the information necessary to start a company, startups do not need to be in Silicon Valley to have a fighting chance of success. Therefore, tech hubs are sprouting throughout the U.S. and the rest of the world and new general partners are able to capitalize on these new ecosystems.

2. Starting a company is cheaper then ever and the advent of the Internet, cloud, and mobile means companies are far more efficient than ever before. WhatsApp was sold for $19 billion and only had 55 employees. Tomasz Tunguz very eloquently highlighted the efficiency in which Atlassian operates at. Because of this, smaller amounts of capital are needed and smaller funds can have a much bigger impact than ever before. It’s no surprise there has been a huge increase in micro VC funds over the last few years.

3. Markets are bigger than ever. Because nearly 2 billion people have a smart phone, startups can reach large number of customers faster than ever before. Larger and more markets means more winners.