As confirmation that the venture industry’s fortunes continue to be tied to public market performance, Venture Economics has announced its preliminary quarterly Private Equity Performance Index (PEPI) results in the US for Q4 2000. Final results will be published in Venture Economics’ 2001 Investment Benchmarks Reports published later this summer.
Returns to limited partner investments in venture capital funds fell for the fourth consecutive quarter, and finally dipped into negative territory with a -6.3% return for the quarter ending 12/31/2000. However, for the entire year the venture industry still managed an impressive 37.6% return. When compared to NASDAQ’s dismal quarterly and annual performance of -32.8% and -25.6% respectively, the venture industry fared remarkably well. Investors had been expecting returns to fall from their precipitous heights, and are probably relieved that returns are as healthy as they are. However, investors continue to be surprised by how much the performance of their venture portfolios is correlated with the public markets.
Figure 1.Venture Economics’ US Private Equity Performance Index? (PEPI)
Investment Horizon Returns as of 12/31/2000
Fund Type / 3 Mo. / 1 Year / 3 Year / 5 Year / 10 Year / 20 Year
Early/Seed / -4.8% / 51.2% / 93.7% / 65.5% / 35.8% / 23.8%
Balanced / -7.3% / 33.2% / 61.5% / 42.9% / 27.0% / 17.5%
Later Stage VC / -8.1% / 19.9% / 31.7% / 31.1% / 25.2% / 18.3%
All Venture / -6.3% / 37.6% / 64.8% / 48.0% / 29.9% / 19.9%
All Buyouts / -2.5% / 9.7% / 14.3% / 17.4% / 16.6% / 19.2%
Mezzanine / -0.2% / 14.9% / 10.8% / 11.1% / 12.4% / 11.7%
All Private Equity / -4.0% / 20.0% / 30.3% / 28.3% / 22.1% / 19.3%
Not all Funds Created Equal
Long-term investors do have a lot to be happy about. Venture capital returns are usually analysed on a “vintage year basis.” Since funds have fixed lives and are generally closed to new investors, funds are usually grouped by the year they are formed.
By this measure, older funds have seen less degradation with the current market volatility, while funds formed more recently show more volatility in their performance. Figure 2 indicates, for example, that investors in funds that were formed in 1990 and thus near the end of their lives showed a 26.7% annualised return since inception and only showed a drop of 1.4% in the 4th quarter of 2000. Compare this to the phenomenal 105% return enjoyed by investors who invested in funds that started in 1996 at the beginning of the Internet craze and the 78.8% return to funds that started investing in 1998.
Figure 2. Vintage Year Results for Selected Years
Results as of 12/31/2000
Annualised / Distribution
Year of / Return / to Invested / Return in
Fund /d Since Inception / Capital / 2000 Q4
Formation / (%) / (times) / (%)
1990 / 27.6% / 2.57 / -1.4%
1996 / 105.1% / 3.61 / -9.3%
1998 / 78.8% / 0.55 / -4.0%
Venture Economics/National Venture Capital Association
Figure 2 also demonstrates what portion of returns has actually been realised as distributions and how much is unrealised. The DPI, or distribution to paid in ratio, for funds formed in 1990 shows that these funds returned a total of 2.57 times invested capital while funds formed in 1998 have only returned 55% of invested capital. This means that much of the significant returns these more recently formed funds have provided are still unrealised. However, investors in the 1996 funds have received an astounding 3.6 times their invested capital back already. Full vintage year results will be released later this summer in Venture Economics’ Investment Benchmarks Report. They are currently available via Venture Economics’ VentureXpert database.
Returns Depend on Distributions and Valuations
Venture returns are predicated on both distributions of stock and cash proceeds to investors and on valuations of unrealised investments. On that basis, the fourth quarter is significant in that distributions of proceeds back to investors fell to the lowest levels seen since mid-1999, and the average net asset value of venture funds also fell to levels not seen since the same period. These distributions in the most recent quarter were down over 50% from their levels in the first quarter of 2000, and valuations also fell nearly 9% from the same period. Figure 3. Venture Capital Funds
Average Fund Distribution and Valuations
Avg. Fund / Avg. Fund
Distribution / Valuation
Quarter / ($mill) / ($mill)
1998-1 / 12.4 / 39.9
1998-2 / 18.2 / 39.6
1998-3 / 13.3 / 37.6
1998-4 / 12.3 / 40.1
1999-1 / 14.4 / 44.1
1999-2 / 21.6 / 55.0
1999-3 / 27.1 / 64.3
1999-4 / 58.4 / 97.3
2000-1 / 100.2 / 105.1
2000-2 / 68.7 / 105.7
2000-3 / 85.3 / 104.3
2000-4 / 47.5 / 95.9
Venture Economics/National Venture Capital Association
Again, much of this was anticipated since investors knew the remarkable run-up in performance seen in 1999 was not sustainable either in the public or private markets. And even with the fall in the 4th quarter of 2000, the return the venture industry saw for the year was still higher than any year since 1995 except for 1999. (Figure 4)
Figure 4. US Venture Capital Funds
Annual Performance Statistics
Year / Annual
Ending / Return
12/31/1994 / 11.1%
12/31/1995 / 47.4%
12/31/1996 / 33.5%
12/31/1997 / 28.0%
12/31/1998 / 17.8%
12/31/1999 / 165.3%
12/31/2000 / 37.6%
Even with the downturn in the IPO market late last year, distributions are still historically respectable as venture investors turn to the M&A market for exits when the public markets dry up.
According to Jesse Reyes, Vice President, Venture Economics, “None of this came as a surprise to any investor who has been in this industry for long. The volatility in the public markets and the meltdown in dot.com land were sure to have an impact. As these figures indicate, the oldest funds were largely immune from the risk of the past few years, but probably won’t have as high a return.
“In the coming months we will see which firms have talent and which ones were riding a tailwind. Odds are that given the investment levels seen in 2000, funds formed last year will have a tough time seeing the historical return levels that previous vintage years enjoyed,” he said.