Whatever happened to “venture is hard” ?

I’m scratching my head. It seems that with the overwhelming notion that “software is eating the world” pretty much everyone is starting a venture fund… or doing an ICO. Somehow you’re led to believe that a giant macro rising tide lifting all boats will suddenly allow everyone to defeat the traditional maths of venture capital. Is that realistic ?

The case for the emerging manager

We have to start with facts, not myths, and we can dispel the notion that a small handful of firms generate all the returns. I won’t rehash all the numbers but as this Cambridge Associates piece of research demonstrates:

the widely held belief that 90% of venture industry performance is generated by just the top 10 firms (which our analysis shows was somewhat relevant pre-2000) is a catchy but unsupported claim that may lead investors to miss attractive opportunities with managers that can provide exposure to substantial value creation.

To understand distribution of returns CA analyses the top 100 investments in venture over 18 years (1995 through 2012). Why? Because these 100 deals generate anywhere from 72% (2012) to 277% (2000) of overall returns. When we say venture is all about the outliers, there it is.

The analysis of these top 100 venture investments as measured by value creation shows an average of 61 firms accounting for value creation in the top 100 investments in venture capital per year; and 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.

This helps explain the gold rush, particularly with new managers like Felicis publicizing 9X cash on cash returns.

You’d be forgiven to want a piece of that.

But making money in venture is hard…

Professionally managed venture firms (say, Accel) spend years training and / or observing aspiring venture professionals to determine whether they’ve got “the touch”. As one of my former partners put it, “we want to see if they can put all the building blocks together and become great investors”.

Intellectually there’s nothing, on the surface, inherently complex about how venture returns are generated, but in practice it seems a few people get it right consistently whilst others toil through their careers and never lift themselves out of mediocrity. Luck, persistence, talent combine to allow some people to shine.

Jason Lemkin ran napkin maths on how many venture capitalists are successful which rings very true.

His conclusion: 12% of VCs are a success. Max.

Another way to look at this is to look at multiples distributions per company. The best data I could find on this comes from Correlation Ventures via Seth Levine at Foundry:

In other words, a 10X is really hard to generate!

And Staying at the top is harder

Mike Annunziata dropped an important note in the comments that is worth highlighting, showing that historically top funds tend to stay at the top. Of course folks like Michael Cendana, who built an entire business around emerging managers, would disagree about the conclusions, but you’re starting to get a sense of exactly how tough it is to be a great L.P.

This actually isn’t the sentiment. The sentiment is that there is persistence of venture returns (defined as 3x Net MOIC at the fund level) within the top firms, and that the highest ex-ante probability of achieving venture returns at the portfolio level is by investing in these funds. It’s recognized that other firms can and will earn venture returns, but that it is near impossible to know which ones will prior to investing in the blind pool. The research, linked below, confirms that within venture there is persistence for both pre- and post-2000s funds.

Read the report.

Deconstructing the Europe Midas List

To further illustrate the point, I took a look at the newly-publishing European Midas List. Some obvious conclusions (leaving Israel out for a second):

• A few deals drive most of the presence: Supercell (Comolli then, Rimer, Zennstrom); King (Chalfen, Holmes), Skype (Zennstrom), JustEat (Holmes), Avito (Parsson then DeRycker), SkyScanner (Paterson), Criteo (Grossman, Botteri, Vidal), Zoopla (Destin & Klein)
• Emerging success stories are equally concentrated: Spotify (Hommels, Parsson then DeRycker), Farfetch (Court), The Hut Group (Briggs), Transferwise (Klein, Sohoni, Hammer), FundingCircle (Rimer then Nelis), Deliveroo (Mignot & Rimer, Destin), BlaBlaCar (Botteri, Vidal) Improbable (Klein)
• Fund concentration is striking : Index (4 partners with I’m sure Martin Mignot knocking at the door), Accel (4), LocalGlobe (2), Atomico, Northzone, SEP … although emerging managers are also represented and will continue to progress: Phenomen, Mosaic, Felix (both ex Advent), BGF (ex Balderton).

Conclusion

In venture, and I don’t quite know why, success is tough to achieve and even tougher to replicate. It took me ten years to have any form of track record, I’ve been investing for seventeen and I’m not that much closer to telling you exactly what makes a successful investor. What I do know is that it’s genuinely tough. I’m a firm believer in the emergence of strong new firms (IA Ventures, Founder Collective, Floodgate, Felicis to name a few) but feel that the current frenzy to start / fund new managers looks a lot like an end of cycle phenomenon. But then again, maybe the rising tide will lift all boats.

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