Venture capital over the past 10 years has rewarded its investors with low returns, high risk, poor liquidity, and high fees.  It is thus an extremely inefficient asset class for investment, where “efficiency” means that each increment of risk is compensated for by some increment of additional return.

Why has venture failed so miserably?  Here’s my two cents….

Investment returns in venture are produced at the intersection of the underlying performance of the portfolio company and the decisions of the VC driven by year of fund life considerations. When a VC sees an incredible opportunity in a prospective investment, the VC first must answer the question: “What year of life is my fund in?” The answer to that will determine to a large degree the actions of the VC.

This is relevant because the academic research shows that venture returns are negatively correlated with capital inflows. The recent decade’s experience is mostly of large amounts of capital coming into the asset class. Many funds were raised in 2000. Because of the 10 year fund structure, the closing of a fund in 2000 pre-determined that 2000-2003 would be the optimal times to deploy capital and 2007-2010 would be the optimal times to exit venture investments. History has shown otherwise. The vintage issues around the 10 year fund are in fact a form of market timing, which requires you to be right twice, on the buy and again on the sell. And like market timing generally, venture returns benefit when little money is coming into the asset class. My conclusion is that vintage year risk is additive to total fund risk but that the LP is not compensated for this risk.