VC Return Numbers are Bogus
There has been a lot of excellent blogging and valuable dialog recently about the Venture Capital Model Being Broken.
Everyone is trying to figure out what happened to the VC industry, and many are making suggestions on how it might be fixed. Unfortunately, a lot of this work is based on bogus data.
Erick Shonfeld's post "A Scary Line Has Been Crossed for VCs" on TechCrunch picked up on some provocative writing by Adeo Ressi, founder of The Funded.com, in his talk at Harvard Business School. This graphic from The Funded got a lot of attention and coverage in the old media.
Fred Wilson wrote an excellent post in response to Claire Cain Miller's article in the New York Times titled "Venture Capital Returns Dip Below Zero." Part of Fred's argument is the data below, from Thomson Reuters and the National Venture Capital Association. Like Fred, I have referred to this data many times. It is regarded as the best available data on many financial asset classes.
The perspectives illustrated in the graphics above seem contradictory. So what's really going on?
In my opinion, nobody really knows because the data on VC industry returns is bogus.
When you look at the returns on an index like the NASDAQ or S&P 500 you can trace back all of the underlying source data to accurate financial information submitted by the public companies as required by law. You can be reasonably confident that every company in these indexes has submitted recent, accurate financial information.
The same is not true of the venture capital industry.
When I ran a family of VC funds, I would get calls all the time from Thomson asking us to submit our data. At first, I dutifully submitted our information. Then I got busy with our portfolio, so I delegated it to one of our junior team members. I was never sure they actually knew how to complete the information forms.
Then we got even busier and nobody in our organization had the time to report all of the detailed information that Thomson was asking for. Thomson would call often. They would track me down at conferences and offer to buy me drinks. I believed in what they were doing and sincerely wanted to help, but I just couldn't find the resources to submit the information they needed.
It bothered me and I occasionally wondered how they could aggregate meaningful data if funds like ours didn't submit their information. I asked one of the Thomson team at a conference once. They looked at the floor and mumbled something about "that being a problem in their industry."
Then one day at a national VC conference the truth hit me like a hammer between the eyes.
I was watching a presentation on the latest statistics on the Canadian industry's dismal investment returns. I kept thinking to myself that the numbers couldn't be that bad. Then the main researcher said something to the effect that there was a bias in the numbers.
The glass-half-full-entrepreneurial-optimist in me leapt on his words and I thought to myself: "Ah, ha! I knew it couldn't be as bad as those numbers up on the screen."
Then the researcher went on to explain that the bias came from the fact that "under performing funds tend not to report". My brain churned for a second as I tried to assimilate that statement. Then it dawned on me. The bias in the data meant that the actual returns were worse than what the numbers showed - possibly much worse.
Since then, I've asked several of my VC friends about this. Some had never wondered about the accuracy of the industry statistics or worried about this bias. Many weren't submitting their data either. There is no question that human nature makes it much less likely that an underexposing fund will report, but some of my friends with good results were often not reporting either simply because of the huge amount of effort it requires.
There has been widespread criticism of the venture industry for not publicly reporting their returns. As the private equity asset class has exploded over the past decade or two, the regulators have tried to improve disclosure. Until we have full disclosure, we will never really know how the venture capital industry is actually doing.
If any of you think I am missing something here, please add a comment.
Thanks to ricklucash who commented below, this graph from the January 12, 2009 Forbes cover story illustrates the VC fund flows perfectly. From that story:
"Venture capitalists have been pouring money into startups over the last several years, but investors haven’t been seeing much in the way of returns.
The last time U.S. venture capitalists returned more money than they invested in startups was 1997. In 2007 VCs put $30.8 billion to work and returned $19.6 billion to the pension funds, foundations and endowments that make up their investor base."