How High are VC Returns?

“Adjusting in this way for the selection bias of firms that go bankrupt, the mean return on VC investments is 57 percent per year, still very large but less dramatic that the 700 percent mean before correcting for selection bias.”

Venture capital (VC) investments carry more risk than most investments in the broad public market and their returns are much more modest than commonly thought, according to a new paper by NBER Research Associate John Cochrane. He concludes that VC investments are not dramatically different from publicly listed small growth stocks.

Estimates of the returns to VC investments can be highly misleading because they typically reflect only those firms that have initial public offerings or are acquired by another company. Private companies are more likely to go public when they have achieved a good return. Those that do not achieve a good return are more likely to stay private or go bankrupt. Therefore, ignoring those companies that stay private only counts the winners; it induces an upward bias in the measure of expected returns for potential investors.

In The Risk and Return of Venture Capital (NBER Working Paper No. 8066), Cochrane includes those companies that stay private — the losers as well as the winners– so as to more accurately estimate the returns on VC investments. His analysis is based on 17,000 financing rounds in 8,000 companies, representing $114 billion of VC dollars, between 1987 and 2000.

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