Over the last year, the venture industry has had a tough time. Many feared that the bull market had pushed valuations to unsustainable heights and would result in a windfall of startup down rounds and cash burn, which would have a negative impact on VC fund performance. But before SVB failed, it was going relatively well.
It might appear that the opposite is true, at least according to a report about the University of California’s endowment. But since this report only looked at funds with vintages of 2018 or later — which haven’t hit the critical J-curve yet — calling these funds “underperforming” wouldn’t be telling quite the whole story, because the numbers don’t take the fund’s lifecycle into account.
Let’s break it down. Most fund lifecycles are about 10 years, but they don’t start making money right away — by design. A fund typically invests the capital for three to five years, which causes its “performance” to drop. Once the fund is deployed, it hits that “J-curve” and starts to see its value climb back up sharply as the assets in the fund gain value.
There are ways to disrupt this timeline: VC firms can sometimes back a relatively early-stage company and exit the investment within 12 months. But 2021 wasn’t normal. Excluding the last two years, what’s been happening at Sequoia would be totally normal in an otherwise healthy market.
So how were most venture funds actually performing? Data shows that as a whole, venture funds, while not immune to market pressures, were doing just fine.
A recent PitchBook report looked into fund performance across VC funds at all stages regardless of maturity. The report found that the rolling one-year IRR was 2.8%, the lowest it has been since Q4 2016, a not particularly bad year for venture.
That figure includes funds across their lifecycle, which implies there are funds in that data set that are still deploying capital. Naturally, those funds will have low or even negative returns at this time. Sure, no one strives for a 2.8% return, but that number includes a whole range of funds out there performing better than that, in addition to the funds at the beginning of their lives.
While cumulative returns for individual quarters were still decreasing through the third quarter of 2022, per the UC endowment report — and this will likely continue for a while — it’s important to remember that venture is a long-term game. The three-year, five-year and 10-year horizon IRRs are clocking in at 26.8%, 22.8% and 16.6%, respectively. It’s worth noting that most large LPs target a yearly return of 7% to 10%.
Looking into both individual LP and fund performance doesn’t raise any strong red flags, either. In fact, it actually shows a few really bright spots.
Los Angeles Fire and Police Pensions reported that its venture portfolio had a net IRR of 10% and a net return multiple of 1.76x through the third quarter of last year. Is that the best performance we’ve ever seen? Of course not, but it is still better than how some of venture’s “top-tier” funds have performed — even in good times.
Recent data from the Los Angeles County Employees Retirement Association shows that two of the best-performing funds since the inception of their private equity portfolio are VC funds with 2014 vintages, which are just on the cusp of reaching maturity, if they haven’t already.
The funds JSV Opportunity Fund 2014 (Jackson Square Ventures) and USV 2014 (Union Square Ventures) posted total value to paid-in capital (TVPI) of 6.94x and 5.98x, respectively, through the end of 2022.
This means that investors were receiving significantly more money than they put in. In TVPI terms, you break even at 1x. Any LP would be happy with those numbers, especially as those funds reach the end of their lifecycle.
Another positive here is that some sizable LPs — who have more data on how their investments are doing than we do — were looking to increase the amount of money they put into the asset class.
Very few have pulled back and some are signaling that they are looking to increase their exposure or find new managers. The University of Michigan endowment stated at a recent board meeting that it will continue to expand its PE and VC portfolio in 2023. The City of San Jose Police and Fire Department Retirement Plan is also looking to invest in venture this year as the asset class is currently under target. Plus, while many said LPs would flock to the familiar, some like the San Francisco Employees Retirement System are still forging new manager relationships in their PE portfolio.
So while it’s no doubt that some funds may be struggling — maybe more so now due to market pressures from the failure of Silicon Valley Bank — current venture performance gives no reason for broad panic yet.
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