At last year’s National Venture Capital Association conference in San Francisco, Jamey Sperans, a managing director at Morgan Stanley, asked each of the venture capitalists in attendance to look to their left, and then to their right. He then predicted that one in three of those VCs present would be unable to raise their next fund--effectively putting them out of business and leaving some startups reliant on venture funds out of luck.
The reason? Mediocre returns. Venture capital isn't just risky for entrepreneurs. It's risky for so-called limited partners, like Sperans, too. They're the ones who provide venture capitalists with money to invest, and they agree to have their money tied up in a fund for ten years or more in exchange for the promise of outsized returns.
As of Speran's comments in May 2013, the average 10-year return for a venture capital fund was 7.4 percent--exactly the same as the Dow Jones Industrial Average and the Standard & Poor’s 500 indexes, which both carry much less risk than an investment in a venture fund. Not to mention the fact that an index fund doesn't tie up an investor's money for 10 years.
So it must come as a relief to the venture community that returns are finally starting to tick back up. According to data from the NVCA, the average 10-year return for a venture fund is 9.7 percent as of December 2013. That’s up from a 10-year return of 8.6 percent as of September 2013, and follows a steadily increasing trend since at least December, 2012.
You’ve got to go back 15 years to really knock the ball out of the park--the 15-year average annual return is 22.6 percent. But just beating the major market indexes is progress.
The improving returns should come as a relief to entrepreneurs as well. Yes, venture capital is the ultimate in "other people's money." Entrepreneurs are building companies with other people's money--that of the VCs. And VCs are getting that money from other people--namely, limited partners. (Although many VCs do invest their personal funds alongside those of their limited partners.)
But returns do still matter. If returns are consistently bad for long enough, limited partners could lose faith in venture capital as an asset class. Sperans, who predicted a year ago that a third of VCs would be unable to raise their next funds, would be right. And that would be very bad for the community of high-flying startups that depend on that money.