#1 Episode - Law of VC

Do Emerging Fund Managers Outperform More Established VCs?

Welcome to the first edition of Law of VC!

In future editions, we’ll explore the following topics:

  1. Emerging Venture Funds (today)

  2. Venture Law (next week)

  3. LegalTech (two weeks)

Today we address our first question:

Q: Do Emerging Fund Managers Outperform More Established VCs?

The bottom line is that YES, emerging fund managers have a slight edge compared to more established venture capital fund managers.

~ Let’s explain why ~ 👇


Emerging Venture Funds

A common disclaimer found in most venture fund subscription documents is:

"Past performance does not guarantee future results."

Q: But isn't the opposite true for VCs? “Don't established, top tier VCs (almost) guarantee their results by outperforming emerging fund managers?”



Established VCs vs. Emerging Fund Managers.

  • Conventional wisdom says that Established VCs hold superior performance over Emerging Fund Managers:

Unlike other asset classes, past performance in the venture industry is a very good indicator of future success. Since entrepreneurs prefer to work with investors who have achieved successful exits, such VCs enjoy a higher likelihood of working with the best startups, and thus a higher probability of successful exits.” —Odin’s Newsletter

"Manager selection is the key to capturing attractive [LP] returns.” —Cambridge Associates.

"Nobody got fired for hiring IBM"
"
Nobody got fired for investing in Sequoia."

CB Insights Shows Experience Isn’t All That Helpful.

  • According to CB Insights, after analyzing the Top 100 VCs in the U.S., this nugget was uncovered:

    “Interestingly, there was also no relationship between investors’ years of experience as a VC and their rank on the list.”



Persistence of VC Returns

  • In other words, if a fund is within the top quartile in Fund I, you can reasonably expect that Fund II will be in the top two quartiles (68% likelihood). However, “[i]dentifying which funds are in the top quartile can be tricky. The reason is that there are different ways to measure results, including various benchmarks, performance measures, and data sources.”

The Case for the Emerging Fund Manager.

The truth lies somewhere in the middle.

  • As we reference the following topics: funds, venture fund managers,venture industry and top lists, an open question is whether these advantages accrue at the level of the VC firm or the individual. All evidence points to the individual, but it should be noted that failure rates from Fund I to Fund II may be as high as 85%—which means perhaps only 15% of Fund I funds make it to Fund II. (See Samir Kaji, Slide #11 out of 27). It’s obvious, but VC fund managers who perform well early have a far better chance of surviving later fund cycles than those who don’t.

    For example, each startup that a VC manager takes public in their first 10 investments predicts an 8% higher IPO rate on any subsequent investment. Similar with M&A exits: One sale in the first batch of 10 investments by a VC results in a +1.8% chance higher exit rate (or a +3.6% difference relative to the average). It’s not just that initial success improves access to deal flow, it predicts the probability of future success after ~50 subsequent investments. Success may breed success, but in venture capital, that wears off over time (See Persistent Effect of Initial Success: “[S]uccess rates appear to decline with experience”). Ultimately, VC firms with larger numbers of investments converge to the industry average success rate.

Conclusion.

The bottom line is that emerging fund managers have a slight edge compared to established VCs in terms of fund performance.


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Best,

Chris Harvey


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