Taking stock of venture capital

Steven Kaplan speaking at the 2010 IVCA luncheon

In the best of times, the venture capital business is a risky one: success rates are uncertain and it has a history of promoting and funding hype during the dotcom bust. The recession and unavailability of cheap credit, one might think, would have added to the industry’s woes.

Yet, the mood was cautiously optimistic in the Chicago Club’s chandeliered Burnham room as people from the industry gathered for the Illinois Venture Capital Association’s annual luncheon. 

Recently-released data from the National Venture Capital Association has brought good news for the industry. VC-backed fund performance has improved in the short-term, on a quarterly and yearly basis. In addition, VC-fund performance has been positive as compared with the S&P 500.

Steven Kaplan, Professor of finance and entrepreneurship at the University of Chicago’s Booth School of Business, added to the cheer with his keynote presentation about the past, present, and future of the VC industry.

Using data from the NVCA, Kaplan calculated that the number of VC deals in the last 15 years as a percentage of the total stock market has remained constant at around 0.10 percent to 0.20 percent. This figure, of course, is barring the outlier dotcom years of 1999 and 2000 when the dollar value of deals comprised 6.5 percent of the total stock market.

One could argue for relative stability of the VC industry in a volatile market. And that argument might be correct. “Venture capital performance has been awful for much of this last decade,” said Kaplan. “But it has mirrored general public market performance.” He added that venture fund performances, in some cases, had beaten public market indices.

Kaplan measured the overall investment return rate or IRR for VC funds and the public market equivalent or PME. While the former measures returns for venture-backed funds, the latter compares their performance to the S&P performance over a period of time.

In both cases, he found that the venture capital industry mirrored existing economic realities. In fact, three of five vintages, or the year in which venture firms began making investments, have had positive returns as compared to the overall stock market and NASDAQ.

Should the VC industry, then, pop the bubbly? Not really.

The news has been mixed closer to home. The number of deals is a good indicator of VC activity. I checked Midwest VC deal data for the last 10 years from the NVCA.


The decade began on an upbeat note with 271 deals in 2001. Things took a turn for worse during the three-year period between 2003 and 2005 that had an average of 166 deals. At the halfway mark this year, only 44 VC deals have been inked, so far.

So, how does an increase in the number of deals affect the economy?

VC deals translate into jobs and revenues. The VC industry lagged the general economy during the recession: 2008 was the best year for the Midwest this decade with 286 deals. According to a study by NVCA, the increase in deals resulted in venture capital-backed companies employing more than 12 million people and generatng nearly $3 trillion in revenue that year.

Not surprisingly, the number of deals dropped by 22 percent in last year’s troubled economy. According to Kaplan, the previous year also represented a substantial decline in dollar commitment terms, a figure of $13 billion or 0.09 percent of the total stock market value.

The future does not hold too many shocks. Kaplan is cautiously optimistic about the return of VC-backed IPOs, whose numbers have gone down in recent years. He predicted a steady rate of 0.15 percent to 0.20 percent, as a percentage of the stock market.

There is a caveat to this number, though.

Kaplan said small, capital-efficient firms with  high success ratios in investments will be responsible for this number.  Effectively, this translates into VC firms that raise fewer funds but are associated with higher returns.   

Efficiencies, anyone?

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