So one of my clients is a venture capital fund in Silly Valley (my name for Silicon Valley). And being that I use to be in the high tech investing game, it’s a nice trip down memory lane.
Remember back in the day when they said it was a good idea to buy a basket of stocks in a hot sector, and needing only one of them to become the next Microsoft for the whole investment to pay off? Well, boy did these guys ever – they’re the real deal. The fund began with $100 million, and one of their first investments was an early round investment in ABC Networks for $5 million. Five years later, at the height of the tech bull market, they distributed shares in ABC Networks to their partners (cashing out in VC speak) with a gain of over $625 million.
Think about it for a minute. It’s the same as buying shares at $1 and selling it at $126 for a gain of $125. That’s a 125x return on the original investment. In percentage terms that’s a 12,500% return over 5 years, or roughly a compounded return of 265% per year over 5 years for their investment in ABC Networks. Overall, the original $100 million fund made over $850 million in capital gains for its investors. Or to put it simply, they turned $100 million into almost $1 billion. Takes your breath away doesn’t it?
Capitalism at its finest.
Note: Names and figures have been changed due to the information being privy to the fund and its investors. The figures used are fictional. However, I’ve maintained the magnitude of the figures for illustration purposes.
As a side note, there’s plenty one could critique – i.e. the market was a euphoric bubble, the investors may not have sold once they received the shares and rode it down, we’ll never see a market like that again, etc, etc. I wanted to give an inside peak at a VC, what can go right, and a reason why people invest in venture capital funds. Hope you enjoy.
Update: I forgot to mention, the standard fees the GP would charge to manage a fund is in the ballpark of 2.5% of capital committed per year and 20% of profits.
Update2: Here’s a good article about Google and its relation to the IPO/VC world.
The weird thing about Crichton is that his stance somewhat contradicts the Luddite angle of his books. Environmentalists and other technophobes and anti-progress activists, after all, tend to like his novels…And the movies that are made out of them perpetuate the irrational fears and phobia he claims to oppose.
Great speeches, but there is something about him I can’t quite figure out yet…
doh! now I know where my comment went. To the wrong post. Oh well.
I shall add the usual 5,000 IPO shares penalty to the screw-up jar.
Dude, if I didn’t know better, I’d think you’re one of those guys who worked in a tech mutual-fund or something.
Sylvain, are you suggesting. . ….. Crichton and In-Cog are. .. …? Hmm. They do sort of look alike. And I’ve never seen them pictured together.
Let’s keep this under our hat for now.
If it was that easy, everyone would do it, and returns would be arbitraged down to the cost of capital immediately. I am an LP in 10 VC funds with 149 sub investments, and I can assure you that they are not all home runs, or for that matter, singles and doubles. There are a bunch of strikeouts in every portfolio.
The only people that believe that VC investors play a 100% probability game are CNBC acolytes and class warfare wealth redistributionists.
R. Hightower, I don’t see anyone here suggesting all VC funds are home-runs. So get off the soap-box. Or stay on it and give us your angle on what works these days.
Hightower,
Absolutely, the vast majority (greater than 90%)of startup investments turn out to be write-offs. But that one time one of them hits it big, boy is it worth it. Luck has a part in it. Good connections have a part in it. I wanted to give an example – a very isolated example – of what happens when things go right.
Always wanted to be a VC. The whole concept of being paid millions for screwing up 90% of the time is extremely appealing to me.
It’s like a government job, without the bad pay.
You didn’t tell us what the return would have been if you had held on to the stock.
Robert, I think you missed the main point of my post.
OK, I’ll bite. what was the point that I missed?
I accept that they hit a 60% IRR. However, Investors who jumped in on VC partnerships in 1999 or 2000 on the basis of historical performances like that, probably haven’t done that well.
Also you did not specifiy if the LP’s recieved free or restricted stock and whther they had the time to dump it before the market fell apart.
All abnormal gains will be competed away. Art Rock and Fred Adler made boatloads of money in Venture deals back before the invention of the quill pen. Now it is harder.
I agree with what you’ve said.
My main point is that a reason people invest in VC’s is to have that small opportunity to hit it big. Technology investing requires a good bit of imagination and fantasizing about what could be. Simply the reason being that the technology and markets you’re hoping to cash in on doesn’t exist yet or is in the growing stages.
Yes, abnormal gains will be competed away. VC’s are trying to catch that abnormal profit between the introduction of a technology and it becoming a commodity.
The whole notion of investing requires a bit of fantasizing on the investor’s part about future profits that they could make.
This fantasizing is what I was trying to get at.
“The whole notion of investing requires a bit of fantasizing on the investor’s part about future profits that they could make.”
Fair enough. OTOH, the Romans had a slave ride in the chariot of a victorius imperator, whose duty it was to whisper in his ear: the glory of this world will pass away.
Fantasy may be a great tool for the VC, but investors need frequent reality checks, lest they fall prey to the many market fads and pitfalls, not to mention the fraudsters who prey on those fantasies. The dot bomb bubble of 1998-2000 was a lesson in that for many investors, most of who will not recoup their losses by writing a book about the experience.
Yes. And many many VC’s fell prey to the fantasy as well, concentrating on the exit strategy as opposed to finding good investments. Shakeouts do have a purpose in getting rid of bad managers as well as bad companies.
On the positive, VC’s are getting much better terms in their term sheets due to capital drying up.
Keep an eye on Google. They don’t need an IPO for many reasons, but it should be a big win if they decide to take it public.