First of all – congrats to the LinkedIn management team and investors. Unbelievable outcome.
Coincidentally the National Venture Capital Association (NVCA) and Cambridge Associates yesterday released VC returns data for 4Q10 which both made for interesting reading and suggests better days are ahead for VC investors – as evidenced by what happened today to LinkedIn. And this is not a post debating whether we are in a bubble…
Except for 15-year returns, performance was better across all time periods in 4Q10 than they had been in 3Q10. As I read the report I was most focused on 1/10/20 year returns data – some of the highlights of what jumped off the page are:
• 4Q10 vs. 3Q10 1-quarter performance was 8.4% versus 3.7%, respectively
• 4Q10 vs 3Q10 1-year returns improved to 13.5% from 8.2% – although the Dow and NASDAQ were up 14.1% and 16.9%, respectively, for the calendar year
• Unfortunately the 10-year performance also lagged the public markets – (2.0)% for VC compared to 3.2% and 0.7% for the Dow and NASDAQ, respectively
• But the 10-year number in 4Q10 of (2.0)% was much better than the (4.6)% 10-year number in 3Q10 – so trending in right direction
• VC performance really shines over 20-year timeframes: 26.3% versus 10.3% for both Dow and NASDAQ
It is quite evident that recent VC follow-on investment activity is driving a very rapid recovery in returns. The enormous mark-up’s we are seeing in the most notable, talked about companies – like LinkedIn – are starting to show up in many other on financings in the market and are now influencing investment performance data. With a number of other high-quality VC-backed companies now poised to go public one would expect to see this improvement only continue.
Not all the news is great though. Later in the report is an analysis of Distribution to Paid-in Capital (DPI) which measures how much LP’s are getting back versus investing into funds; this is a metric many LP’s focus very closely on. The VC model is built on LP’s being able to re-invest gains from early portfolio company investments to fund future commitments – thereby LP’s never actually have to come up with their entire commitment as it becomes in a sense “self funding.” A ratio greater than 1.0 means distributions are paying for the commitment…and we haven’t seen this ratio greater than 1.0 since 1998.
What does that mean? In essence the VC industry has been a net consumer of capital for a decade. And the order of magnitude of the DPI ratio is quite troubling. For funds raised in 2006, DPI is 0.09 – less than ten cents on the dollar. From 2007 to 2009 the DPI is 0.06, 0.05 and 0.01, respectively. Ouch.
Now it is not quite that bleak as LP’s also look at DPI plus Residual Value to Paid-in Capital. This ratio attempts to capture the fact that while not distributed, VC portfolios are still presumably building value – just in private companies. Fortunately that ratio has been above 1.0 since 2000 when it was 0.95 (2010 was 0.99…so I rounded up). Over the past decade this ratio has bounced from 1.04 to 1.30 so at least VC’s were not destroying value – just consuming a lot of capital.
The issue – we all know – is lack of liquidity. Liquidity drives distributions which allow for new funds to be raised and invested, but it also drives valuations. Everyone in Silicon Valley and Route 128 just marked-up all their portfolio companies thanks to what happened on Wall Street today.
Hope it is sustainable. That is an entirely different post.