The Kauffman Foundation, which has ties to the venture industry, has issued a damning study of the business that presents the foundation´s lessons from 20 years of investing in venture capital, which currently has about $249 million of its $1.83 billion portfolio allocated to venture.
Many of the foundation’s criticisms of venture capital will be familiar to people who have watched the industry for the last decade as it has generally failed to produce promised returns. Looking into its portfolio of nearly 100 VC funds, including what it says are some of the most notable and exclusive names (confidentiality agreements barred it from naming them), the foundation found that only 20 of them beat a public-market equivalent by more than 3% annually, and half of those started investing before 1995.
Insiders have long known that only a few funds really outperform while the rest deliver mediocre returns or lose money, which is why the smartest limited partners are highly selective of managers and only commit a sliver of their capital to venture. More surprising is the foundation’s evidence that the vaunted J-curve is a myth. The J-curve describes a widely held belief that venture funds lose money early on as they make risky bets, but that returns soar later on as the winners prove themselves.
Not true in recent years, says the Kauffman Foundation. “There is not consistent evidence of a J-curve in venture investing since 1997,” the report says. In fact, the typical fund in the foundation’s portfolio generated peak returns early on–in time for its partners to raise another fund.
The report also offers support for the belief that small venture funds are the most successful. Only four of 30 VC funds in the foundation’s portfolio with more than $400 million in committed capital produced returns better than those from a publicly traded small-cap stock index fund.
The foundation promises to take its own medicine. It said it will invest in venture funds of less than $400 million whose partners have consistently shown they can outperform public markets and who commit at least 5% of the fund’s capital. It also plans to do more direct investing to avoid paying management fees and sharing profits with VCs. And, it plans to shift money from venture capital to the public markets.
To download the report click here.