Odds long, returns small even for top venture capitalists

Published on UT San Diego, August 7, 2012

I recently chatted with a partner at a Silicon Valley venture capital firm. He is an old friend who had invested in a couple of my deals, so we let our hair down. (I don’t have any but he does.)

Here are some statistics to curl whatever hair you have. In the second quarter of this year, U.S. venture firms raised $5.9 billion (B, as in billion). Of that, 79 percent was raised by just five funds. The rest was distributed among the other 48 supplicants.

The firms with the best track record attract the most dough, which seems logical.

Now, let’s look at the overall returns for the last 10-year period, and only from those venture firms that qualify to be in the top quartile.

To make it into the top 25 percent, you needed to return only 92 cents of every dollar invested with your firm. Think about that number. After 10 years, the investor got back a little less than they put in. However, the firms in this quartile show on paper that there is another 66 cents coming to the investor over the next three to five years, the long tail of the investment period. So, in total, the investor will get back $1.58 over about 14 years, which means that the internal rate of return to the investor was approximately 3.26 percent. And these were the best firms.

And they call this a business?

Oh, one last note, during that time, the fees generated from the money raised were more than $120 million. Nice gig if you can get it.

So here is the question: Why do some funds do so much better? My venture- capital pal and I agreed that the answer is the quality of the team. The dynamics of the investing team really matter, just as the quality of the startup team matters.

I am an avowed bettor on the jockey. But even though I believe that I have a keen insight into the human psyche, a skill informed by 35 years of personal psychoanalysis, I probably still get it wrong 30 percent of the time. And we know that a company’s success is 85 percent defined by the quality of the team (based on my extensive reading about the startup racket), so if even the best team pickers, culture creators, human factor assessors get that aspect wrong 30 percent of the time, then using simple math, one can see that the chance of creating a great team with a great culture is at best only slightly more than 55 percent. I wonder if the same is true of venture capital teams.

Let’s look at their structure for a moment. They are partnerships; they are hierarchical; they have different compensation models; you get paid for what you personally kill; every man for himself; very little allegiance to the company; big egos; high mobility; take the money and run.

You may remember that several months ago we wrote about why companies fail. The study by Harvard Business School professor Noam Wasserman, author of “The Founder’s Dilemmas,” said that 65 percent of the time, it was because the management team “could not get along with each other.” That is a staggering number. If you layer that percentage on top of the problem of creating and assembling a team in the first place, you can see that now the statistical chance of success (venture firm or start-up) is reduced to about 20 percent. You could get better odds in Vegas or the racetrack.

Rule No. 125

Love the jockeys all you want, but be careful going to the betting window. They still have to ride the horse, filling an inside straight is rare, and the house always gets its cut.

Source: From Neil Senturia’s book “I’m There for You, Baby: The Entrepreneur’s Guide to the Galaxy,” which has more than 200 rules for entrepreneurs (imthereforyoubaby.com).

Neil Senturia and Barbara Bry, serial entrepreneurs who invest in early-stage technology companies, take turns in writing this weekly column about entrepreneurship in San Diego. Please email ideas to Barbara at bbry@blackbirdv.com.

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