It Ain’t Broke: The Past, Present, and Future of Venture Capital

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The U.S. venture capital (VC) industry is currently subject to a great deal of uncertainty and controversy. Some observers and practitioners believe that the VC model is broken and that the U.S.

Given the unusual and unexplained paucity of IPOs between 2004 and 2007, we argue there is more upside than downside for the VC vintages of 2001 to 2007. e costs for public companies associated with Sarbanes-Oxley are now smaller and more manageable than they were in 2005 and 2006. ere are more boutique investment banks with incentives to market IPOs. And according to anecdotal reports, there has recently been growth in the pipeline of IPO candidates.

We also note that commitments to U.S. VC partnerships were historically low in 2009, a trend that is likely to continue into 2010 and, possibly beyond. Based on the historical relationship between commitments and performance, the low level of commitments suggests that returns to the 2009 and 2010 vintage years are likely to be strong.

Finally, we consider some of the longer-term drivers of venture capital financing. Corporate funding of innovation has increasingly moved from large, centralized research facilities to various “open innovation” models, including acquisitions and strategic alliances with smaller firms. is increased willingness to reach outside the organization, which reflects the difficulties of managing early-stage innovation within a large corporation, appears likely to create more opportunities for venture investors in the years to come.

We believe there are several takeaways here. First, VC returns net of fees have been competitive with the return from public markets. Second, VC outperforms public markets gross of fees, but GPs capture a lot of the outperformance (on average). Third, there is a great deal of variation over time in whether VC returns outperform or underperform the public markets.

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