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Venture Capital 101
Venture capital accounts for a small portion of overall alternative assets but has a disproportionate impact on the economy. While VC funding amounts are small at around $28 billion annually in the US, VC-backed companies represent over half of the current public company market cap and were responsible for over a third of US jobs. Returns in venture capital are also highly variable, with the top quartile funds achieving average annual returns over 20% compared to under 10% for bottom quartile funds. Success in venture capital relies on identifying companies that can achieve "home runs" or outsized exits in the billions, as these will account for the vast majority of fund returns due to the power law distribution of outcomes.
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Venture Capital 101
- 1. Venture Capital 101 BrentGranado General Partner, Sway Ventures Brett Munster Principal, Sway Ventures
- 2. Quick Background OnUs Brent Granado General Partner MBA Class of 2011 Brett Munster Principal MBA Class of 2015
- 3. Enough about us,lets talk Venture Capital
- 4. Where VC fitsinto the alternative asset landscape by risk RISK EXPECTED+RETURN Fixed+Income+Yield Shorter+Duration Higher+Cash+Pay+Component Lower+Risk Longer+Duration Higher+Multiples Low+Cash+Yield Higher+Risk Venture'Capital Growth Buyout Secondaries Mezzanine Private+Debt Infrastructure Real+Estate
- 5. Where VC fitsinto the alternative asset landscape by capital Commodities Liquid Alternatives Institutional Loans Real Estate Hedge Funds Private Equity Total Money Invested ($Trillions) Venture Capital 0.028 Of#the#nearly# $11#trillion invested#into#alternative# assets#in#2015,# VC#accounted#for#about# 0.26%## Source: http://www.strategyand.pwc.com/media/file/Alternative-investments.pdf
- 6. Source: http://a16z.com/2016/09/11/vc-economics/ Google andApple combined spent about $20 billion in R&D alone. Private equity buyout funds raised about 10x that VC raised. The 500 largest U.S. public companies distributed more than $1 trillion in cash back to their shareholders. Hedge fund assets under management were about $3 trillion. U.S. GDP was about $17 trillion. VC dollars are a fraction of a fraction of a percent of this. The U.S. VC industry raised about $28 billion in new capital. While VC dollars are a significant source of capital for facilitating new business creation, the total capital deployed is remarkably small. Here are some 2015 numbers to illustrate: VC is very much a niche industry
- 7. However, VC doeshave a disproportionate impact on the economy Venture Capital investment as percentage of US GDP in 2015 0.16% Percent of total market cap attributable to VC backed companies in 2015 57% Percent of public companies were funded by VC in 2015 43% Percent of jobs as a result of VC backed companies 2015 38% Source: Stanford GSB, How Much Does Venture Capital Drive the US Economy, 2015
- 8. The top 5companies by market cap were all VC backed Sequoia, Arthur Rock, Matrix Sequoia, KPCB KPCB Accel, Greylock, Peter Thiel Technology Venture'Investors (TVI)
- 9. Source: http://www.citylab.com/work/2013/06/americas-top-metros-venture-capital/3284/ VC capitaltends to concentrate around entrepreneurial ecosystems
- 10. Management Co, LLC 2%Annual Management Fee Venture Fund, LP LPs invests in the fund Initial Investment + 80% of returns 20% Carry GPs invest 1-10% of fund Company 1 Company 2 Company 3 Company N General Partners Venture Capitalists who run the fund Limited Partners Endowments Pension Funds Family Offices UHNW VC Fund Structure – “2 and 20”
- 11. For Limited Partners •Long term investment (10+ yrs) • Not Liquid • High Fees compared to wealth management • Many funds don’t yield desired returns For Companies The day you take outside money is the first day towards the end of it remaining your company – investors need liquidity at some point. Potential Downside of Venture Capital
- 12. Big Upside Potential Asmall allocation has the potential to juice overall returns. Even if the venture fund isn’t successful, the impact on the overall portfolio performance is only minor because of the small allocation. So why do LP’s invest in such a risky, illiquid asset class? 14.75% 4.75%5.00%Return
- 13. U.S. Venture CapitalIRR by Fund Vintage Year Net to Limited Partners Source: Cambridge Associates “US Venture Capital Index and Selected Benchmark Statistics”, 2017 Venture Capital industry returns over the years
- 14. Source: Cambridge Associates“US Venture Capital Index and Selected Benchmark Statistics”, 2014 Top Quartile vs Bottom Quartile U.S. Venture Capital IRR by Fund Vintage Year Net to Limited Partners Large variance in performance between top tier and bottom tier funds
- 15. The Power Law Avery small number of companies drive an overwhelming majority of the returns in venture. In a typical fund of 25 - 30 companies, only 1-3 companies will account for ~95% of the economic return. Because of this dynamic, VCs need large exits to cover the rest of the portfolio’s losses. This is critical to understanding why VC’s behave the way the do. Source: CB Insights VC returns are driven by the “Power Law”
- 16. Magnitude of “Homeruns” The“Babe Ruth Effect” What is interesting and perhaps counter-intuitive is that the very best performing funds actually lose money more often than good performing funds do. However, great funds not only have more home runs in their portfolio, they have home runs of greater magnitude. Magnitude of “Homeruns” Percent of portfolio that loses money Source: Chris Dixon, A16Z http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-capital/ VC’s need to swing for the fences to be successful
- 17. Venture is allabout Magnitude, not Frequency
- 18. $100M Fund LPsexpect at least 20% IRR $300M Return Assuming it takes 6-7 years on average for companies to exit, that means a fund needs to return roughly 3x the size of the fund to achieve desired returns. Lets do some simple VC math
- 19. “Power Law” ineffect Return Profile # of Companies Investment ($M) Return ($M) Total Exit Amount ($M) % of Return Fail 60% 15 $48 $0 $0 0% 1x Return 30% 7.5 $24 $24 $120 8% Homerun 10% 2.5 $8 $276 $1,380 92% Total 25 $80* $300 Assuming the venture fund owns 20% of their portfolio companies, a $100 million venture fund needs to be part of at least $1.5 Billion worth of exits in order to generate the desired returns. *Assumes 2% management fee for the life of the fund (10 years). $1,500 More VC math – achieving a 3x return
- 20. “Power Law” ineffect Return Profile # of Companies Investment ($M) Return ($M) Total Exit Amount ($M) % of Return Fail 60% 15 $240 $0 $0 0% 1x Return 30% 7.5 $120 $120 $600 8% Homerun 10% 2.5 $40 $1,380 $6,900 92% Total 25 $400* $1,500 The bigger the fund, the larger the exits have to be. Again, assuming 20% ownership, a $500 million venture fund needs to be part of at least $7.5 Billion worth of exits in order to generate the desired returns. *Assumes 2% management fee for the life of the fund (10 years). $7,500 Same exercise, but with a larger fund
- 21. In 2010, AndreessenHorowitz (one of the top Silicon Valley VC firms) invested $250K into Instagram via its seed round. Two years later, Facebook acquired the company for $1 billion, netting the VC firm $78 million (312x return). However, at the time, Andreessen Horowitz had $2.7B under management, meaning they needed to return $8.1B to their investors. This means the firm would have required 103 more Instagrams across their funds to make the model work! This is why bigger firms have to write bigger checks. The Instagram mistake?
- 22. The Three AssRule Big Ass Market Kick Ass ProductSmart Ass Team So what do VC’s look for in start-ups?
- 23. But Its NotAlways Easy To See The Future… ? A VC’s job is to evaluate what a company can become, not what it is today
- 24. Lets take alook at two Case Studies
- 25. Uber started itsplatform with high end, on-demand black car services. Because not very many people use private car services, many thought it was “too niche” (VC code for too small) of a market. As a result, many early investors passed because their market analysis was wrong. Uber’s true market size isn’t even the Taxi market, its much bigger. For example, in San Francisco, Uber generates 3x the revenue as the entire SF taxi market at its peak and is still growing. Source: http://www.businessinsider.com/uber-revenue-san-francisco-2015-1 Revenue($m) 2015 San Francisco Market Uber vs Taxi Case Study #1: Uber and its small market size
- 26. In 2008, AirBnBwas a marketplace for air mattresses on the floors of people's apartments. Most investors could not imagine most people using this product, let alone completely disrupting the lodging industry. At the time, the company was seeking to raise a $150,000 seed round at a $1.5 million valuation. In other words: That $150,000 would’ve meant a 10% stake of AirBnB, an investment that would now be worth $310 million. All but one investor passed. Case Study #2: AirBnB and its product evolution 500,000 stays per night 65,000 cities 2.3m listings
- 27. Brent Granado General Partner,Sway Ventures brent@swayvc.com @BrentGranado Brett Munster Principal, Sway Ventures brett@swayvc.com @bmunst Now that everyone is an expert VC, any questions?