Professional Documents
Culture Documents
Who We Are
FAQ
650.249.4258
Blog
Contact Us
Career
Stock Options & RSUs
Planning & Taxes
Investing Insights
Wealthfront News
Retirement
Search
Miscellaneous
Like
81
11
Demystifying Venture
Capital Economics, Part 1
Tweet
424
Share
397
Andy Rachleff
7 Comments
T
he other day my co-founder, Dan Carroll, asked me
a number of questions about Venture Capital returns because he was stunned by the
valuations of some recently announced deals. After I answered the question, Dan and
Let Wealthfront
manage
investments
for you.
a few colleagues
who were within
earshotyour
encouraged
me to share
my perspective on
the subject because it is so poorly INVEST
understood.
NOW
Much has been written about the financial performance of the companies backed by
https://blog.wealthfront.com/venture-capital-economics/
1/11
9/25/2014
venture capitalists, but very little has been written about the economics of the venture
capital industry itself. With this post we open the kimono on who funds VCs, what
returns they expect and how the best VCs consistently succeed in outperforming those
expectations.
https://blog.wealthfront.com/venture-capital-economics/
2/11
9/25/2014
These 20 firms dont change much over time and are so oversubscribed that they are
very hard for new limited partners to access. The premier endowments are considered
the most desirable limited partners by venture capitalists because they are the most
committed to the asset class. Even these endowments, though, have a hard time
getting into funds if they werent there in the beginning. Occasionally new firms like
Benchmark and Andreessen Horowitz emerge and break into the top tier, but they are
the exception rather than the rule.
3/11
9/25/2014
of 6 7% annually. Im not sure what that means for the current appropriate return
expectation, but its still probably at least in the mid teens.
If 20% of a fund is invested in deals that return 10x in five years and everything else
results in no value then the fund would have an annual return of approximately 15%.
Few firms are able to generate those returns.
Buyer Beware
Over the past 10 years, venture capital in general has been a lousy place to invest.
According to Cambridge Associates the average annual venture capital return over the
past 10 years has only been 8.1% as compared to 5.7% for the S&P 500. That clearly
does not compensate the limited partner for taking the increased risk associated with
https://blog.wealthfront.com/venture-capital-economics/
4/11
9/25/2014
venture capital. However the top quartile (25%) generated an annual rate of return of
22.9%. The top 20 firms have done even better.
Being willing to intelligently take this leap of faith is one of the main differences
between the venture firms who consistently generate high returns and everyone
else. Unfortunately human nature is not comfortable taking risk; so most venture
capital firms want high returns without risk, which doesnt exist. As a result they often
sit on the sideline while other people make the big money from things that most
people initially think are crazy. The vast majority of my colleagues in the venture
https://blog.wealthfront.com/venture-capital-economics/
5/11
9/25/2014
capital business thought we were crazy at Benchmark to have backed eBay. Beenie
babiesreally? How can that be a business? The same was said about Google. Who
needs another search engine. The last six failed. The leader in a technology market is
usually worth more than all the other players in its space combined, so it is not worth
backing anyone other than the leader if you want to generate outsized returns.
Needle In a Haystack?
According to some research I did back in the late 90s, there are only approximately
15, plus or minus 3, technology companies started nationwide each year that reach at
least $100 million in revenue at some point in their independent corporate life. These
companies tend to grow to be much larger than $100 million in revenue and usually
generate return multiples in excess of 40x. Almost every single one of them would
have sounded stupid to you when they started. They dont today. Investing in just one
of these companies each year would lead to a fund with an annual rate of return in
excess of 100%.
Speaking of outsized returns, these days the breadth of the Internet has made it
possible to generate returns that were never before imagined. Companies like Airbnb,
Dropbox, eBay, Google, Facebook, Twitter and Uber return more than 1,000 times the
VCs investment. That leads to amazing fund returns.
Related Posts:
https://blog.wealthfront.com/venture-capital-economics/
6/11
9/25/2014
Be Exceptional at
One Thing,
Outsource the
Others
WhatsApp: What an
Acquisition Means
for Employees
Like
81
11
Tweet
424
Share
397
Tags: Andy Rachleff, returns, Silicon Valley, VC, venture capital, venture capital
economiccs
7/11
9/25/2014
Reply
8/11
9/25/2014
into it. On the other hand, while I agree that it is only a few VCs that end up making the
oversized returns that makes this asset class so attractive, I thought it was a little simplistic
to state that it is the same 20 odd VCs that continue to make the right calls every year.
Given the uncertainty surrounding many of the ideas that the VCs back, it must be really
difficult to consistently back the right blue-sky ideas year after year. I am sure there is some
amount of churn in who the top performing firms are every year.
Reply
Leave a Reply
Name (Required)
Email (Required)
Website
Comment
Submit Comment
Connect with us
https://blog.wealthfront.com/venture-capital-economics/
9/11