US venture returns take a dive

US venture returns plunged to 17.2 per cent last year, compared with the annual returns of between 30 per cent and 40 per cent delivered by the asset class since 1994, according to the Venture Economics Private Equity Performance database. Full results of the performance survey of 1,050 US private equity partnerships will be published in the 1999 Investment Benchmarks report.

The study highlights the correlation between quarterly returns from venture funds and Nasdaq market returns during the past ten years. While the performance of venture funds is apparently less volatile than that of the public market, this is probably attributable to venture firms’ conservative valuation policies, which will tend to have a dampening effect on quarterly returns.

During the past four years, the correlation of all US venture funds with small-cap stocks has been 59.7 per cent, whereas the average correlation for the previous 20 years was only 31 per cent. The extent to which venture fund and Nasdaq performance are linked is highlighted by the -3.5 per cent negative return attributable to venture funds during the third quarter last year. The largest quarterly downturn since 1990, this coincided with a ten per cent fall in the Nasdaq market, which was in turn accompanied by a significant drop in IPO numbers.

Although the slow-down in IPO activity is driving US venture firms to seek alternative exit mechanisms, leading to an increase in M&A activity among venture-backed companies, Jesse Reyes, managing director of Venture Economics Information Services, notes that the venture industry and the public markets are closely interconnected. Reyes observes: “The public market impact is related not only to direct exit opportunities, but also to the valuation comparables that the public market provides for technology and other venture-backed companies.”

It is interesting to note the contrast between US and European performance trends. Whereas in Europe, buyout funds have historically tended to deliver superior returns, later-stage vehicles have underperformed venture funds by a substantial margin over one-, three-, five- and ten-year horizons (see table 1).

Discussing investors’ quest for portfolio diversification, Reyes says the negative correlation between venture and buyout funds during the past two decades makes both [types of vehicle] an attractive part of the modern asset portfolio’.

Meanwhile, despite the slump in returns last year, US venture funds are continuing to raise unprecedented levels of capital. Nearly $25 billion flowed into US funds last year, matching the total raised by the industry between 1980 and 1987. Similarly, the record $17 billion invested by US venture capital firms last year equals the total deployed between 1980 and 1985. Just as that period marked the boom in personal computers, the current frenzy appears to be driven largely by the Internet revolution and the concomitant dot.com craze’.

Average investment sizes too have reached record levels: the current average of around $6 million is double the 1992 figure, while the average valuation of US venture-backed companies at the time of investment now stands at circa $30 million compared with $20 million six years ago.


Table 1: US Venture and Private Equity Performance Returns to LPs for the period to 31.12.98

Sample 1-year 3-year 5-year 10-year 20-year

Early/Seed stage 25.7% 37.7% 33.7% 19.7% 16.8%

Balanced Venture 10.8% 23.6% 24.2% 16.1% 14.0%

Later-stage Venture 26.5% 27.3% 29.8% 23.9% 18.2%

All Venture 17.2% 27.9% 27.4% 17.7% 15.1%

All Buyouts 10.9% 19.2% 17.2% 16.4% 19.6%

Mezzanine 11.7% 10.4% 10.4% 10.2% 10.8%

All Private Equity 12.8% 22.0% 20.5% 16.9% 17.1%

Source: Venture Xpert