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Written by: Do small venture capital funds outperform this issue of Venture Capital Update, SVB
large venture capital funds? SVB Capital Capital reviews historical return data and
Sven Weber is interested in understanding this finds evidence to support the commonly-
Managing Director
650.855.3049 issue and the many dynamics necessary held view that funds at the smaller end of
sweber@svb.com for a healthy venture capital industry. the size spectrum consistently outperform
Median fund sizes in venture capital have larger funds across vintage years. We
Jason Liou declined dramatically in recent years, derive this result from an analysis of the
Research Senior Associate
650.855.3043 and many limited partners have liquidity performance of SVB’s own portfolio of
jliou@svb.com constraints that have caused them to funds as well as data from Preqin, one of the
reduce or pull back from allocations to industry’s leading providers of performance
Edited by: the asset class. At the same time, many information. In total, we examine returns
Aaron Gershenberg
Managing Partner general partners realized little to no from more than 850 venture capital funds
650.233.7436 carry (profit participation) over the past based in the United States.
agershenberg@svb.com decade. Lastly, realized and unrealized
returns for venture capital funds over the There are many compelling reasons
Note: The original version of past ten years have been disappointing. for the attractiveness of small funds.
this report dated April 2010
contained an incorrect chart
These ongoing developments have posed Managers of such funds often have
on page 5. Please accept fundraising challenges for the surviving industry-specific expertise and focus on
this corrected and expanded
report with our apologies. firms and are gradually leading to a particular strategies or sectors compared
compression in overall fund sizes. to those of larger funds which usually
target multiple stages and sectors.
View the Fourth Quarter
2009 U.S. Venture Capital We believe the decline in fund sizes Small funds tend to have a strong
Snapshot is a healthy trend for the industry. In general partner commitment, which
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 1
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Venture Capital Update
heightens the alignment of interests sectors (technology, life science and clean for both venture fund managers and
with limited partners and potentially technology). In many cases they employ entrepreneurs will help ensure that the
increases investment discipline. In funds later-stage strategies that require large industry has the necessary discipline and
with these characteristics, one or two investments of capital. Many of the most return objectives that are needed during
investments can provide positive returns successful large funds have also built times of low liquidity and a difficult exit
for the entire portfolio. Limited partners brands and a depth of expertise which environment, which will help set the
have recognized the potential upside allow them to outperform small funds. stage for significant outperformance as
of investing in small funds and often Our data indeed reveals that a few large markets improve.
expect managers to attain multiples of funds have been able to consistently
at least 3x or an internal rate of return deliver a TVPI multiple of 2 or above. Analyzing the Performance
(IRR) of at least 25 percent. Our analysis Profile of Small Funds
corroborates this general view: We find SVB Capital believes that the distribution To examine the correlation between
that a higher portion of smaller-size of sizes for funds with vintage years 2010 venture capital fund sizes and relative
funds have achieved significant returns through 2012 will be dominated by performance, SVB Capital analyzed a
on a total value to paid-in capital (TVPI) funds which are $250 million or less in data set comprised of 509 venture capital
and distribution to paid-in capital (DPI) size. Larger brand name firms with top- funds from Preqin, a provider of data on
basis relative to large funds across most performing track records will be able to the venture capital and private equity
vintage years between 1981 and 2003. close on funds greater than $250 million industry.1 The funds in the data set have
if they are able to demonstrate a realistic at least $50 million under management
On the other hand, an increasingly ability to not only achieve multiples of 3x and span vintage years 1981 through
select group of brand-name firms that and greater for early-stage investing and 2003. We also reviewed performance
have generated outsized returns will 2x and greater for late-stage strategies, figures from a set of over 350 funds
continue to find limited partner support but also generate an IRR north of 20 with vintage years 1995 through 2008
to raise large funds. Many of these percent. Across the industry we expect that make up part of SVB’s portfolio of
firms have successfully raised significant firms to reduce fund sizes from prior venture capital investments.
amounts of capital because they have funds by 25 percent to 50 percent in the
demonstrated an ability to adapt to next few years. For this analysis, we based performance
changing environments over the course on two metrics that are commonly used
of their previous funds. Some of the most In the current environment all managers to assess the return on investment of
successful brand-name firms employ are actively looking to right-size and a venture fund: total value to paid-
multiple strategies to achieve their results, adjust their funds in order to maximize in capital (TVPI) and distribution to
such as diversification across stages return potential and ensure their paid-in capital (DPI). TVPI provides a
(early vs. late and growth), geographies ability to raise funds in the future. The multiple value on the entire portfolio
(multiple regions including global) and high cost of accessing venture capital — both distributed capital and the net
1
Preqin collects fund performance data from public sources, typically reports from pension funds and other institutions that must provide their financial performance reports as
mandated by the U.S. Freedom of Information Act (FOIA) or similar legislation in foreign countries. Preqin advertises that its data have less selection bias than samples collected
via surveys or client investments because Preqin’s information would not omit better- or worse-performing funds or be skewed upwards by institutional clients’ investment picks.
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 2
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Venture Capital Update
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 3
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Venture Capital Update
It is important to note that fund sizes the late 1990s, we examined the TVPI The data also seems to suggest that
in the venture capital industry have distribution for funds formed between the downside potential of small funds
fluctuated significantly over the last few
decades. Following the dot-com bubble, (C): Fund Sizes Have Declined Since 2007
the average fund size declined until
2004, when optimism across the industry Mean Venture Capital Fund Sizes Since 1981
caused both the number of funds and the 500 $200
2 Chart shows funds in Thomson Reuters’s ThomsonONE database that have had an interim or final close with a disclosed fund size. Funds that were more than three standard
deviations away from the mean were removed from the sample.
3
The median-sized fund was not defined for vintage years 1981 through 1983, as there were only one or two funds in the data set.
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 4
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Venture Capital Update
4
To study fund performance over incremental vintage year periods, we divided the funds in the Preqin dataset into the periods 1985-89, 1990-94, 1995-99 and 1999-2003 and
sorted them into “buckets” based on TVPI performance. There was insufficient data to include funds with vintage years 1981-84.
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 5
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Venture Capital Update
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 6
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Venture Capital Update
2. Leverage specialized industry capital partnerships and allowing it to funds have outperformed their peers
expertise attract world-class management teams to are more likely to continue raising large
While established managers often get its portfolio companies. Differences in funds in the future. These managers have
the most recognition for top-quartile size, strategy and positioning allow small usually succeeded in taking advantage of
returns, they are not alone in their and large funds to view each other as their brand name, have built strong teams
success. Managers of smaller funds partners rather than as competitors. able to execute on larger investments
typically develop a tighter focus on a or are more likely to invest in growth
specific niche or strategy that gives them 4. Fewer home runs are needed to or later-stage companies, which require
a competitive edge over other investors. return the fund larger amounts of capital. They may
Focused managers can leverage their Smaller fund sizes, and hence fewer also be successful investing in capital-
sector and geography-specific networks investments, force managers to focus intensive sectors such as hardware,
for high-quality deal flow. They use on capital efficiency. These managers cleantech and pharmaceuticals. High-
their differentiated expertise to more tend to pursue a strategy of significant performing managers show an ability
quickly evaluate opportunities, thereby initial ownership coupled with selective to execute strong pricing discipline
increasing their chance of winning in a participation in follow-on rounds that during the investment process and
competitive process. have compelling valuations and strong bring sector-specific value-add to their
investor syndicates. In funds with these portfolio companies. They use their size
3. Ability to complement large funds characteristics, one or two investments to maintain a high ownership percentage
The deep experience and relationships in can return the entire fund. in portfolio companies and may choose
specific sectors and regions that managers not to rely on syndicates with other
of small funds cultivate place them in a Top-Performing Managers venture capital firms to finance their
unique position in the venture capital of Large Funds Will companies. In many cases, past success
ecosystem. This ensures a differentiated Continue to Successfully helps them create successful exits for
reputation, making the fund a syndicate Raise Large Funds their companies.
partner of choice for larger venture Venture capital managers whose large
Latest Fund Vintage Target ($M) Previous fund Vintage Final Close ($M)
Battery Ventures IX 2010 $750 Battery XIII 2007 $750
Grotech Partners VII 2009 $250 Grotech Partners VI 2000 $410
Highland Capital Partners Highland Capital Partners
2009 $400 2006 $800
VIII VII
Polaris Venture Partners VI 2010 $500 Polaris Venture Partners V 2006 $1,000
Redpoint IV 2010 $400 Redpoint III 2006 $400
Trident Capital Fund–VII 2010 $400 Trident Capital Fund-VI 2005 $400
Venrock VI 2010 $350 Venrock V 2006 $600
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 7
May 2010
Venture Capital Update
Some large funds have multiple strategies Please Take Our Two-Minute
with many partners, and on a dollar-per- Survey
partner basis, operate like a few small SVB Capital welcomes questions and
funds combined. For example, a $500 comments you may have about smaller
million fund that targets three industry venture capital funds. If you’d like to
sectors (technology, life science and clean participate in a survey on this topic, please
technology) may have specific allocations click here (or go to http://questionpro.
to those sectors that do not change over com/t/Ajp2ZHWNC). All comments will
the life of the fund. In such a vehicle, be kept confidential, and we will be happy
each of the sector strategies is sometimes to send you a summary of the results after
managed by an investment committee the survey closes on May 31, 2010.
comprised solely of partners with expertise
in their respective industry. We are interested to get your feedback
on questions such as:
A Reduction in Fund Sizes °° Over the last 12 months, how has your
Is Positive for the Venture view on the attractiveness of small
Capital Industry funds changed?
We anticipate that the venture capital °° What do you feel are the most compelling
industry will contract in size by 25 to reasons for investing in small funds?
50 percent both in the amount of capital °° What do you feel are the primary risks
raised and deployed and the number for investing in small funds?
of active firms. The increased focus on °° Should limited partners hold higher
differentiated strategies, investment return expectations for small funds
discipline and capital efficiency as a result relative to large funds?
of the scaling down of fund sizes will °° Do you think small funds with vintage
help drive returns for an asset class that years 2010 or 2011 will have higher
has long been an outsized contributor returns than large funds?
to innovation and economic growth. °° What sector(s) do you think will realize
SVB Capital expects this will contribute the best venture capital returns?
to limited partner and general partner
optimism in 2010. Should the public
and M&A markets continue to improve,
we expect that venture capital returns
will outperform other private equity
investment opportunities.
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 8
May 2010
Venture Capital Update
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of Funds Percentage of Funds
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of Funds Percentage of Funds
Source: Pregin
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 9
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Venture Capital Update
However, the relatively small number of funds that fall into the “large” category may introduce some statistical irrelevancy to
the comparison. There were only 14 funds in the dataset that were more than $1 billion in size, compared to 30 funds that were
larger than $800 million and 47 funds that were larger than $600 million.
30
<1.0x
153
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%
Percentage of Funds
Number
Vintage Years 1995-2003 of Funds
Larger Funds Defined as Greater Than $1 Billion
14
<1.0x
Source: Pregin
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 10
May 2010
Venture Capital Update
This update is for informational purposes only and is not a solicitation or recommendation that any particular investor should
invest in any particular industry, security, or fund. This material, including without limitation to the statistical information
herein, is provided for informational purposes only. The material is based in part on information from third-party sources that
we believe to be reliable, but which have not been independently verified by us and for this reason we do not represent that
the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is
it to be relied on in making an investment or other decision. You should obtain relevant and specific professional advice before
making any investment decision. Nothing relating to the material should be construed as a solicitation, offer or recommendation
to acquire or dispose of any investment or to engage in any other transaction.
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 11
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Venture Capital Update
San Francisco Bay Area 228 304 $9.9 $2,235.1 Venture Capital
Buyout and Mezzanine
New England 108 143 9.1 983.9
Southern California 70 86 8.1 566.2 $70
New York City Metro 55 89 8.7 459.2 $60 65.4
Midwest 61 84 6.4 392.1 $50
South 43 43 8.5 363.9
$ (BILLIONS)
$40
Mountain West 35 63 9.6 336.0
$30
Pacific Northwest 31 44 9.5 293.4
$20 26.2 27.1
Texas 35 50 5.7 200.8 20.3
$10 16.2 14.1
Mid-Atlantic 35 47 5.2 180.7 8.5 3.6 5.2 4.2 2.1 4
Potomac 21 31 5.9 123.9 $0
Research Triangle 12 21 10.1 121.8 3Q 4Q 1Q 2Q 3Q 4Q
2008 2009
Other Northern CA 5 2 3.6 17.9
Other 2 7 3.0 6.0
Islands/Alaska 2 2 1.6 3.3
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 12
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Venture Capital Update
IRR Performance (%) by Vintage Year (U.S.) Cumulative IRR Performance (%) by Stage (U.S.)
Num Cap
Vintage Num of Cap Wtd Pooled Upper Lower of Wtd Pooled Upper Lower
Year Funds Avg Avg Quartile Median Quartile Fund Type Funds Avg Avg Quartile Median Quartile
1996 36 59.2 83.0 113.9 33.0 1.3
Early/Seed VC 612 7.7 18.6 14.6 2.6 (5.3)
1997 62 46.1 49.3 59.6 20.0 (0.9)
Seed Stage VC 66 3.5 9.2 14.1 5.7 (1.1)
1998 76 22.9 17.4 10.6 1.2 (4.7)
Early Stage VC 546 7.9 19.5 14.6 2.5 (5.6)
1999 110 (6.8) (5.4) 0.6 (5.8) (14.3) Balanced VC 459 6.9 13.4 14.2 5.0 (1.0)
2000 126 (0.3) 0.6 1.9 (3.0) (6.9) Later Stage VC 214 4.6 13.0 14.8 5.3 (1.4)
2001 57 1.0 2.0 7.3 (0.7) (4.2) All Venture 1,285 6.7 15.1 14.6 3.9 (2.8)
2002 20 0.3 1.8 2.4 (1.2) (3.1) Small Buyouts 180 8.2 15.3 17.2 7.1 (0.1)
Med Buyouts 123 10.9 16.1 20.5 7.9 (1.2)
2003 17 4.2 3.9 8.6 2.9 1.1
Large Buyouts 99 9.0 11.6 15.2 6.3 (1.8)
2004 23 0.4 1.0 5.5 (1.7) (6.1)
Mega Buyouts 142 (3.3) 8.5 13.0 4.4 (3.0)
2005 22 1.0 3.8 6.2 (0.7) (7.8) All Buyouts 544 (0.3) 10.5 16.8 6.5 (1.3)
2006 33 (5.5) (4.9) 1.4 (5.2) (13.3) Mezzanine 73 5.7 7.7 11.8 7.1 1.2
2007 22 (9.1) (4.2) 3.0 (12.8) (17.2) Buyouts and Other PE 717 1.0 10.1 14.7 6.6 (0.9)
2008 12 (28.7) (25.7) (22.1) (29.2) (37.9) All Private Equity 2,007 2.4 12.1 14.6 4.8 (2.0)
Source: Thomson Reuters. Data are as of September 30, 2009. Source: Thomson Reuters. Data are as of September 30, 2009. Figures are for all funds
in database, vintage years 1969-2008.
U.S. IPO vs. M&A Transactions for US. Venture Liquidity Events
Venture-Backed Companies by Industry
2007 2008 1H 2009
Number of IPOs Industry IPO M&A IPO M&A IPO M&A
Number of M&As
Business and Fin. Services 8 92 1 50 1 51
Cons. Goods and Services 7 50 0 45 2 43
100 3
1 0 2 Energy and Utilities 2 6 0 0 0 4
3 Biopharmaceuticals 19 30 1 29 0 23
80
0 Healthcare Services 2 9 1 8 2 3
60 Medical Devices 8 21 2 15 0 22
Medical Software and IT 3 11 0 8 0 6
89 92 84 86
40 79 Ind. Goods and Materials 1 5 0 4 0 5
77
Comm. and Networking 10 44 0 30 0 25
20 Elect. & Computer Hard-
3 12 0 17 0 17
ware
0 Information Services 0 0 0 0 0 0
3Q 4Q 1Q 2Q 3Q 4Q Semiconductors 7 25 0 28 1 18
2008 2009 Software 8 178 2 146 2 108
Other 0 0 0 0 0 1
TOTAL 78 483 7 380 8 326
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 13
May 2010
Venture Capital Update
Number of Deals The direction of price changes for 112 San Francisco Bay Area companies
Amount Paid ($B) receiving financing, as compared to their previous rounds.
Down
$12 100 Flat
Up
92 77 79
89 80%
84 86
$9 75
70% 73
$ (BILLIONS)
7.3 60%
$6 50
50% 54
5.1 4.9
$3 25 40% 46 46 47
3.5 41
2.9 2.6 30% 36
33 32
$0 0 29 30
20% 25
3Q 4Q 1Q 2Q 3Q 4Q 22 23 23
2008 2009 10% 15
19%
12 13
0%
3Q 4Q 1Q 2Q 3Q 4Q
2008 2009
60%
50% 55% 55
40%
30%
20% 25%
19%
10%
11%
-3% -6%
0%
-10%
3Q 4Q 1Q 2Q 3Q 4Q
2008 2009
Dialing Down: Venture Capital Returns to Smaller Size Funds VENTURE CAPITAL UPDATE 14
May 2010
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2400 Hanover Street Palo Alto, California 94304
Phone 650.855.3000
3000 Sand Hill Road, Building 3, Suite 150 Menlo Park, California 94025
Phone 650.233.7420
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guaranteed by Silicon Valley Bank or its affiliates. Rev. 05-24-10.