Truth in “Silicon Valley” about VC returns

If you watched the HBO series “Silicon Valley” last season you might recall a show, where Jared the PiedPiper CEO, asked another founder of a VC backed start-up if he had even considered taking less money in his latest round of venture capital (VC) funding instead of getting the highest valuation.  This insightful piece of advice, is not only true for the better performing VC firms, but provides us with an understanding of the instrumental components of successful VC funding.

The poor performance of private equity and VC portfolio’s is well supported in the academic research, especially when considering the risk of these investments.  A 2012 Study, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2053258,  by the Kauffman Foundation found that the heroic stories of Google and Facebook win the hearts minds of the public, but VC returns have not outperformed the public markets since the late 1990s and since 1997 have lost money.

However, some skill among the VC community might be noted in a few firms or individuals.  In fact, a 2015 Study, http://onlinelibrary.wiley.com/doi/10.1111/jofi.12249/abstract, in the Journal of Finance found that 85% of the returns were coming from 10% of the VCs.  The same VCs that take companies public or have successful sales or mergers, continue to have prosperous investments. So, if you are looking for VC funding and you are one of the few that get it, you probably want to go with the most successful and skilled VC in your industry.

However, not all of this out performance is attributed to skill.  Because exactly as Jared pointed out the successful VCs don’t have to pay as much for their investments.  In fact in a 2004 Study, http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2004.00680.x/pdf,  in the Journal of Finance it was shown that highly reputable VCs pay in the range of 217% to 4% less for investments.  So, not only is skill and reputation at play in this persistence performance, but so is, just frankly, paying less.