Introduction to Corporate Finance

20: Entrepreneurial Finance and Venture Capital

20-3e THE PROFITABILITY OF VENTURE CAPITAL AND PRIVATE

EQUITY INVESTMENTS

Interpreting the data on venture capital and private equity returns is controversial, and industry assessments

tend to differ significantly from those presented by academics. Figure 20.3 (on page 703) describes five-

year rolling average annual returns for venture capital funds, the S&P 500, and the Nasdaq 100 Index over

the period 1990–2008, as presented in the National Venture Capital Association (NVCA) Yearbook 2009.

This chart suggests that VC funds outperformed US-listed equities in most years. Repeated examples

of boom-and-bust investment cycles in which very high realised returns prompt excessive new capital

inflows into venture capital funds, which in turn cause returns to drop sharply over the next harvest cycle,

have been documented in the academic literature. Although a 30% compound annual return was typical

for venture capital funds during the late 1970s and early 1980s, returns fell short of this every year from

1984 to 1994. Returns were again at target levels in 1995 and 1996, and then surged in 1999. However,

more recent returns following the collapse of the Nasdaq market in March 2000 – and then again in

2008 during the global financial crisis – have been disappointing. Even so, the returns on VC investments

during 2008 were better than the −38.5% return posted by the S&P 500 that year.

Researchers have found a strong positive correlation between US venture returns and returns on

US small share mutual funds. This relationship highlights the importance of a healthy public share

market for new ventures in general, and for IPOs in particular. Because VCs prefer to exit via an IPO,

and because the returns from these IPOs partially flow into new venture investments, any decline in the

share market’s appetite for new issues has an immediate negative effect on the venture capital industry.

Table 20.4 compares the performance of the Australian PE and VC markets to Australian equity and

bond markets over the first quarter of 2014, year to 31 December 2014 (YTD) and the past one-, three-,

five-, 10- and 15-year periods. It shows that the Australian PE and VC sector (measured in dollar returns)

significantly outperformed the equity and bond sectors, suggesting that it might provide good portfolio risk

diversification opportunities for equity and bond investors. In contrast to US data, Australian PE, VC and

small-cap equity asset classes seem to bear little resemblance in their performance over different time frames.

TABLE 20.4 THE COMPARATIVE PERFORMANCE OF AUSTRALIAN PRIVATE EQUITY AND VENTURE CAPITAL

TO 31 DECEMBER 2014

This table summarises the performance of the Australian PE and VC industry (represented by the Cambridge Associates
LLC indices in Australian dollars and US dollars) compared to the equity and bond sectors.

Index 1-quarter 1-year 3-year 5-year 10-year 15-year

Australia Private Equity & Venture Capital

Index (A$)^1

5.61 21.79 16.16 12.50 10.69 12.85

Australia Private Equity & Venture Capital

Index (US$)^1

–1.11 13.47 8.33 10.91 11.40 14.16

S&P/ASX 300 Index 2.94 5.30 14.70 6.48 7.38 8.10

S&P/ASX Small Ordinaries Index –3.89 –3.81 0.58 –2.01 2.27 3.41

UBS Australia Bank Bill Index 0.69 2.69 3.18 3.83 4.86 5.03

UBS Australian Composite Bond Index 3.96 9.81 6.45 7.33 6.52 6.76

Note: The Cambridge Associates LLC indices are an end-to-end calculation based on data compiled from 62 Australian private equity and 24 Australian

venture capital funds, including fully liquidated partnerships, formed between 1997 and 2014.

1 Pooled end-to-end return, net of fees, expenses and carried interest.

Source: Australia Private Equity & Venture Capital Index and Selected Benchmark Statistics, December 2014, Cambridge Associates LLC, p. 3. Copyright © 2014 Cambridge

Associates LLC All rights reserved. The Cambridge index information may not be copied, used, or distributed without Cambridge’s prior written approval. The data is provided ‘as

is’ without any express or implied warranties.

Antoinette Schoar, MIT

‘We find that there’s

a very large amount of

variation in returns of

different funds.’

See the entire interview on

the CourseMate website.

COURSEMATE

SMART VIDEO

Source: Cengage Learning