Unlocking the Power of Data with VenCap’s David Clark | E1906
29 Feb 2024 (7 months ago)
David Clark joins Jason.
- David Clark, the Chief Investment Officer at VenCap, a UK-based fund of funds and investment advisor, joins Jason for the podcast.
- David went viral on Twitter for breaking down returns from 32 years of investments at VenCap.
- David's viral tweetstorm analyzed 32 years of investment data from VenCap.
- The analysis revealed that the top 1% of investments accounted for 50% of the total returns.
- The top 10% of investments accounted for 80% of the total returns.
- The bottom 50% of investments lost money.
- The importance of recognizing and supporting top-performing companies.
- The need for patience and letting successful investments run their course.
- The danger of selling top-performing investments too early.
- The importance of diversification to mitigate risk.
- The value of long-term investing and staying invested through market cycles.
- VenCap invests in a diversified portfolio of venture capital funds.
- The firm focuses on funds with a strong track record and experienced management teams.
- VenCap also invests in early-stage companies directly.
- The firm's investment process is based on rigorous research and analysis.
- The venture capital industry is growing rapidly.
- There is increasing competition for deals.
- Valuations are rising.
- The industry is becoming more globalized.
- VenCap believes that the future of venture capital is bright.
Looking at the data behind VenCap’s approach to alpha vs beta, managers and their over 500 investments to date.
- VenCap has made around 500 fund investments since its founding in 1987.
- Initially, VenCap had a generalist approach to venture investing, but over the last 10-15 years, they have concentrated their investments on 12-15 groups of managers.
- The goal of VenCap is to hit the upper quartile return, which is similar to the actual pooled return for venture overall.
- The challenge in venture investing is that it is hard to consistently produce upper quartile funds.
- VenCap found that the majority of the 110 managers they backed were only generating a median return, and only a handful were able to consistently produce upper quartile funds.
- Longevity in venture investing is not just about building a good brand.
- To consistently produce upper quartile funds, managers need to have a repeatable process and a differentiated strategy.
- They need to be able to identify and invest in the best companies, and they need to be able to add value to those companies.
- VenCap looks for managers who have a deep understanding of the industries they invest in, and who have a strong track record of success.
- They also look for managers who are passionate about their work and who are committed to helping their companies succeed.
What distinguishes longevity and success in VC.
- Venture capital (VC) is a power law industry, with a small percentage of companies generating the bulk of the value.
- The top 1% of exits account for more than half of the total exit value produced by all venture-backed companies globally.
- A relatively concentrated group of managers consistently invest in the top 1% of companies, including Sequoia, Andreessen Horowitz, and Kleiner Perkins.
- VC is not about minimizing risk, as 50-60% of deals in early-stage funds don't return capital.
- The best VC managers are able to consistently back the top 1% of companies, which drives the bulk of the performance in the VC industry.
- They have the same amount of losses as other managers, with 6 out of 10 startups returning zero capital.
- About half of the startups that don't return capital end up at a zero valuation.
- Success in VC is about the very small number of outlier exits that generate significant returns.
Analyzing the data from David's chart covering 12,000 companies and the power law.
- The data used includes just under 12,000 companies.
- Out of these companies, 113 are fund returners, which represents just over 1% of the total.
- A fund returner is a single company investment in a fund that returns the entire committed capital of that particular fund.
- Fund returners can return multiple times over, not just once.
- Three factors play into fund returning outcomes: the size of the exit, the size of the fund that backed the company, and the percentage of ownership the fund has in the company at the time of exit.
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Portfolio strategy and finding that 1% of fund returners.
- The optimal number of names in a portfolio depends on the investment stage, with early-stage funds targeting around 30 names for a fund size of $400 million to $800 million.
- To achieve 10-15% ownership in a company, an investment of $5 million to $20 million per company is required, with some funds reserving 15-20% of their fund for follow-on investments.
- A diversified portfolio with a mix of strategies is important for risk management, balancing the potential for high rewards with the risks involved.
- David Clark from VenCap emphasizes the importance of balancing risk and reward when investing in startups.
- The decision of writing a 30% check as a single investment or layering it over time depends on factors such as the company's progress, market dynamics, and execution capabilities.
The value of investing in a company over a longer period of time.
- Investing in a company over a longer period of time can lead to higher returns.
- Even though a fund may be successful on paper, it is important to consider the potential returns of investing in a smaller number of breakout companies.
- Seed managers who focus on identifying and investing in exceptional companies early on can generate significant returns.
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The challenges VenCap faces when looking at seed managers.
- VenCap finds it difficult to select successful seed managers.
- Despite backing 110 different managers, including seed managers, VenCap has not found consistent success in this area.
- Rather than persist in an area where they lack a competitive advantage, VenCap focuses on markets where they can access top-performing managers and achieve consistent upper quartile performance.
- VenCap has had conversations with LPs more active in the seed space, such as Michael Kim from Send Down.
- VenCap questions whether seed managers' outperformance during the latter stages of a bull market, such as 2017-2021, can be sustained over an entire market cycle.
- During that period, seed managers benefited from aggressive markups on their seed deals and the ability to sell into later-stage rounds, generating DPI for their investors.
- Since late 2021, the market has changed, making it harder for seed managers to transition from Series C to Series A.
- Pricing has come down, and terms are becoming more onerous.
- Companies that have not reserved capital may face difficulties raising capital in the current market conditions.
- VenCap anticipates an increase in pay-to-play rounds, recap rounds, and other challenging fundraising scenarios in the next 12 to 18 months.
- VenCap is interested in seeing how seed managers who performed well in late 2021 will fare in the next two to three years as they revalue markups and face liquidity challenges.
The importance of strategy and timing on selling.
- Many early-stage managers miss out on secondary opportunities to sell their positions in startups.
- Proactively selling shares can create tension between founders and investors, leading to reluctance to sell.
- Deciding when to sell can be harder than deciding to invest.
- The best managers recognize when they have a top 1% company and let it run to capture maximum value.
- Selling too early can result in missing out on significant returns, a bigger mistake than not investing in the first place.
- Some managers have sold their positions only to see the company crash afterward, making them look like geniuses in the short term but missing out on long-term gains.
- Public companies that went public in the 2021 vintage have seen significant declines in market cap, highlighting the risk of taking early liquidity.
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- Tracking secondary offers to maintain discipline in selling fund stakes.
- Secondary offers can be shady, with Hustlers trying to buy or sell positions.
- LP stakes are also being contacted for potential sales or bids.
- Jason mentioned his first fund is 4.9x-5x, leading to interest in taking a strip.
- David personally doesn't need liquidity but is curious about these strips.
Managing successful GPs and having them ‘stay in the game’.
- Crosspoint, a successful venture capital firm in the late 90s, decided to close down after making enough money, demonstrating honesty and integrity.
- Some venture capitalists are driven by passion and competition, continuing to invest and work with founders until they are unable to do so.
- Bringing new blood into venture capital firms is crucial to avoid succession issues and ensure the continued success of multigenerational firms.
- Limited partners (LPs) often don't provide direct feedback on what they dislike about a strategy or fund, making it challenging for venture capitalists to improve.
- David Clark, a partner at VenCap, emphasizes the importance of understanding market dynamics and investor preferences when structuring venture capital deals.
- VenCap prefers managers with premium carry levels, as long as it is justified by strong performance.
- VenCap believes that less capital is better than more capital for venture funds, as it allows for better alignment of interests and prevents the fund from becoming a capital allocator rather than a venture investor.
The misunderstandings of the J-Curve.
- The J-curve, representing the initial decline in a fund's performance before it starts to rise, has returned after a decade.
- VenCap's current fund (Fund 16) faced a challenging fundraising environment, with 90% of investments below 1x in the J-curve, indicating increased competition for the best companies.
- Limited capital availability can foster creativity and efficiency in startups as founders focus and optimize their resources.
- The return of the J-curve and current funding constraints are seen positively, encouraging a more focused and disciplined approach to building startups.
- VenCap's David Clark discusses the possibility of a billion-dollar fund return, citing examples of companies like Facebook, Uber, Robinhood, WhatsApp, Snowflake, Coinbase, Roblox, UiPath, Slack, BigCommerce, and Stripe.
- Predicting which companies will reach a $10 billion valuation is challenging, as not all unicorns from the last cycle may achieve that status again.
- Clark believes many companies are currently overvalued, and loss ratios could increase in the future, with 50-60% of companies not returning capital to investors.
Preparing with founders for when things may go south.
- The seed stage has become more challenging for founders, with many startups facing closure despite receiving funding during the market peak.
- New entrants in the VC space may lack the experience to make tough decisions and have difficult conversations with founders.
- Successful VCs face the challenge of having their investment decisions scrutinized based on their track record.
- Data analysis can help identify top-performing companies, and top-performing VC managers allocate more capital to their best-performing ones.
- It is important to be selective in supporting founders and focus on those with the highest potential for success.
- Despite revenue growth, many successful companies have faced near-death experiences, leading investors to believe in the potential for a turnaround with additional funding.
- Fund managers may be reluctant to give up on investments, hoping for a sudden improvement in the company's performance.
- Dave Clark will be invited for a year-end wrap-up show in December.
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