Venture capital returns are finally starting to outpace seemingly humdrum indexes like the Dow Jones and the S&P 500. Why that's good news for you.
Good news for venture capitalists is good news for you. And finally, we've got some good news.
The National Venture Capital Association, on Monday, released data showing that venture funds are starting to show better returns, thanks in part to a stronger market for initial public offerings.
Why should you care how well venture funds do? Aren't all those guys filthy rich already? Well, venture funds get the money they use to invest from so-called limited partners--pension funds, insurers, endowments, and other institutional investors. For the limited partners, venture capital is considered a risky asset class.
Over the past 10 years, venture capital hasn't done much to deserve the higher risk. Instead, returns have lagged supposedly ho-hum indexes such as the Nasdaq Composite and the Dow Jones Industrial Average. At last year's annual National Venture Capital Association conference, Jamey Sperans, a managing director with Morgan Stanley, warned the VCs in attendance that, based on current returns, a third of them could expect to be unable to raise their next funds. If that were to happen, it would mean that there'd be less capital available to be invested in startups.
Meanwhile, much has been written about the so-called Series A crunch. It's not so hard to get seed funding, but getting that first round from an established venture capital firm is becoming more difficult. And valuations, according to a study from Pepperdine University, are unusually high. The only way this has a chance of ending happily is if VC returns rise and limited partners keep believing in the VC firms.
That's just what's starting to happen, according to data from the NVCA and Cambridge Associates. The most recent quarterly returns have been pretty great at 6.5 percent, which, if it could be sustained, works out to about a 25 percent annual return, according to John Taylor, the NVCA's head of research. A year ago, that quarterly number was less than 1 percent.
Also a year ago, the one-year return on its U.S. Venture Capital Index was 7.7 percent; now it's 15.1 percent. The three-year return has also inched up, to 14.4 from 12.2 percent.
Go out five or ten years, though, and the industry's recent difficulties become clear: The five-year annual return is 7.5 percent (still better than it was a year ago, at 4.5 percent) and the ten-year return is 8.6 percent, up from 6.1 percent a year ago. The 20-year return picks up some survivors of the dot-com boom and some biotech wins, and looks a bit cheerier: 26.1 percent compared to 24.2 percent a year ago.
The one, three, five and ten-year returns, while improving, are still unimpressive compared to the less-risky Dow Jones, NASDAQ, and S&P 500 indexes. All three beat the venture capital index at the one, three, and five-year time frames, and venture capital provides just a one-point advantage at the 10-year time frame. With more IPOs in the pipeline, there are at least hints that's starting to change.