Venture Capital Had a Great 2013—But Public Markets Were Still Better

In an industry obsessed with creating the next big thing, it can be easy to forget that a lot of big ideas simply crash and burn.

So here’s a little reminder: Last year, American venture capitalists put together their best annual performance since 1999. But it still wasn’t good enough to beat the public stock markets, which are cheaper, safer, and much more liquid investments.

Clearly, that’s a bad deal for many of the people who supplied money to VCs. But it’s much harder to say why VCs have done so poorly in the past decade—or whether things have changed enough to make the next decade a better bet.

The newest data on VC performance comes courtesy of Cambridge Associates, an industry insider that analyzes venture firm performance and produces anonymous information about the sector’s ups and downs.

That means you can’t tell which firms are winning or losing. But you can see how the broader VC sector is performing when compared to public stock market indexes.

In its July report, Cambridge Associates wraps up the full-year performance for VC and private equity investments, and it wasn’t exactly pretty. The firm’s VC index grew 27.2 percent in 2013, the best annual performance in 15 years. VC firms also recorded the second-largest payout for VC investors since 2000.

But that wasn’t enough to beat the Dow Jones Industrial Average, the Nasdaq Composite, the Russell 2000, or the S&P 500. You actually have to go back 15 years to find VC performance that outperforms the stock markets enough to truly justify the high fees, long-term lockup, and risk of those investments.

So why has VC done so poorly over the past 10 years? It’s hard to find a clear answer. But there are some good educated guesses out there.

Anand Sanwal, CEO of VC analysis software company CB Insights, says the winner-take-all nature of venture investing means that it can be hard for a broad-based investor to get a good return on their investment. Since the biggest wins go to a handful of firms, even decent wins can be swamped by a long list of underperforming funds.

“Ultimately, it matters what funds you as an investor are in. And so it’s not a bad asset to invest in broadly as when it outperforms, it really outperforms,” Sanwal says. “Said another way, if you are an LP in Sequoia Capital or Union Square Ventures or Spark Capital, you’re probably a pretty happy camper.”

Harvard Business School professor Josh Lerner sees it a little differently.

“The power law property of VC returns has characterized the industry’s returns since its earliest days, so is unlikely to be the explanation,” he says. More likely reasons, he says, are slow IPO markets and “change in the nature of entrepreneurship: changing market structure and regulatory environments meant that it was harder to capture outsized returns as a startup.”

And then here’s the simplest explanation of them all: maybe it was just bad luck. “VC has always been a seven fat years, seven lean years kind of business—this was just a bad series of years,” Lerner says.

At least one prominent venture capitalist is growing weary of discussing the lean years. In a recent series of blog posts, Upfront Ventures partner Mark Suster argues that the past 10 years or more of bad performance was a long-term shakeout of the over-investment from the 1999-2000 tech bubble.

Today, there are fewer VC firms. At the same time, the cost of high-tech entrepreneurship has dropped, while the number of connected consumers has skyrocketed, creating fertile ground for big tech industry victories, Suster argues.

“Looking ahead at the next decade, I am excited by what I believe will be viewed as one of the best and most rational investment periods for venture capital,” he says.

Ashby Monk, the executive director of Stanford University’s Global Projects Center and a regular columnist on institutional investing issues, says VC funds that successfully navigated the Great Recession deserve credit for pulling out of the worst economic climate in decades.

But Monk is less sympathetic to the idea that the tech bubble at the turn of the century is still a big factor in VC performance. He also tends to agree with the Kauffman Foundation’s bombshell 2012 report on venture investing, which said the entrepreneurship-focused foundation was rethinking its strategy after poor VC performance that it says has been indirectly encouraged by limited partners who don’t hold venture firms accountable.

“I don’t necessarily buy that we’re still dealing with this overhang from 1999. That’s a step too far,” Monk says. “I think the last five years have been fabulous for everybody, and you have seen some big exits—and yet, the returns to the LP’s aren’t there. So don’t tell me this is just a macro thing.”

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