Are the Strong Recent US Venture Capital Returns Bankable?
No, not yet, as just over 10% of last year’s performance was realized.
While venture capital (VC) investing is a long-term, multi-year—in many instances, a decade plus—investment strategy, it is still worth noting that the one-year US VC return of 50.1% ranks second only to 1999 for the best calendar year performance and the eighth-best rolling one-year performance since we started tracking US VC returns in 1981. Much of this return was fueled by the fourth quarter 2020 quarterly return, which clocked in at 26.5%, placing the quarter on the leaderboard of the top five quarters ever, along with most of 1999 and first quarter 2000. The strength of the last year’s performance has also lifted our US VC pooled benchmark over longer horizons, with the trailing 20-year, ten-year, and three-year returns hitting 7.2%, 17.2%, and 28.2%, respectively.
During 2020, the pandemic accelerated the ascent of technology and tech-enabled services across multiple facets of our everyday lives, allowing work, doctor visits, and global commerce to continue when the rest of our lives were at a standstill. Basically, the necessity of surviving a global pandemic led to a lot of invention and technology adoption, the key beneficiaries being those inventive companies and their investors. According to Pitchbook and the National Venture Capital Association, the venture ecosystem invested $166 billion in 2020, a 18.1% increase over 2019’s $140 billion; and that’s not including all the non-traditional VC fund capital investing, which by some estimates can be more than the VC ecosystem itself.
While the US VC return in 2020 was eye-popping, nearly 90% of it was due to an increase in unrealized value, and just over 10% was from net distributions during the year. Overall, including the contribution from publicly traded companies, the net asset value of our US VC index leapt to $400 billion, nearly a 50% increase from 12 months earlier. Almost half of that increase was attributable to companies that were public by the end of the year. Having publicly traded companies in private benchmarks is not unusual, as many VC-backed companies go public in any given year (in 2020, it was 136, including SPAC–related activity, and managers are typically subject to lock-up periods post IPO, after which they may seek to sell their fund’s holding and distribute realized gains back to limited partners or distribute the stock. What is more unusual is that at the beginning of 2021, roughly a quarter of Cambridge Associates’ US VC index comprised publicly traded companies, nearly 3x as high as the same metric two years earlier. So, ironically, private market returns are being materially driven by publicly traded companies.
The last time we saw a similar level of performance in US VC was in the dot-com era. The dot-com bubble and subsequent bust ultimately delivered low double-digit returns for the 1998 vintage year benchmark and negative returns for the 1999 vintage, the most active vintages of that era. Back in 2000, those two vintages were posting triple-digit internal rates of return and total value to paid-in capital multiples (TVPIs) exceeding 2.5x and 1.4x, respectively, based largely on unrealized valuations. Hundreds of VC-backed companies went public in the dot-com era, benefiting from a favorable stock market environment and investor exuberance in accessing and participating in the ascendant innovation economy. During this period, many companies lacked substantive and citable operating performance; so, when investor enthusiasm subsided, so did the valuations, much like what happens to the foam when you pour a glass of warm soda over ice; the foam bubbles rise and can almost overwhelm the glass, making one think the actual soda will rise to match the foam, when in fact the foam falls to meet the level of the soda. Today, 20 years later, the 1998 and 1999 vintage years have actually delivered 11.9% and -0.9% pooled returns, and 1.5x and 0.9x TVPIs, respectively.
It does take quite a bit of time to know what you have in terms of actual returns: 61% of the $40 billion in US VC distributions generated in 2020 came from pre-2012 vintage years. Experienced VC investors understand the timeframe and constant commitment required to be there when the returns emerge for any given vintage year, which can often be a decade later.
Current US VC returns reflect strong public share price performance and increased later-stage private market valuations. Compared to the dot-com era, VC-backed companies going public over the last two years have been “older,” with established operating models, revenues, and observable actual operating metrics, so one could interpret today’s glass of soda as half full. VC-backed companies are further benefiting from significant capital thirst for return in a low-return environment, which may be providing some of today’s “foam.” That said, longtime VC investors understand the slow build required to participate in the headline returns currently being registered, and they also understand realized performance in a program may ultimately look a little different than what is reported today.