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Fishing in Venture 🎣

With the arrival of spring just around the corner, my mind is already drifting to the rivers and fly fishing – an endeavor that, oddly enough, shares a lot with the venture capital world. I mean this is why I started ‘Fishing in Venture’. Just like scouting for the right spot on a river, the goal of an early-stage investor is to catch that one “startup” that'll make the whole trip worthwhile. Most times, you're testing the waters, switching flies, trying to see what works – acknowledging that many won't even look at your fly.

There is a common saying in the VC world. Out of every ten investments, the harsh reality is that seven might not pan out (meaning turn to $0). One might just return its value or incur a loss, and another might break even. But then, there's always that one – the elusive, prize catch that delivers a return that trumps all the previous losses. This one keeps investors casting lines in search of that next big hit.

Drawing parallels between choosing the right fly to lure in those wary fish and selecting startups for investment, it becomes evident that both processes rely on understanding the environment and adapting. Each new river presents a unique challenge, requiring a mix of intuition, experience, and a bit of luck to find success. From understanding how markets interact with disruptive technology to gauging the character of a founder. It’s this blend of feeling, experience and the thrill of discovery that makes both fly fishing and venture capital an endless journey of learning. In this week's 'Ebbs & Flows' section, I'll be diving into the historical data and expectations for returns within VC funds. If you're considering investing in a VC fund, exploring angel investing, or simply curious about the returns VCs anticipate from their investments, then you'll want to stay tuned.

Fish of the Week 🐟

Recently, I just finished watching “WeCrashed” on AppleTV. It is a fantastic dramatization of the rise and fall of the startup WeWork. This is a story that will be re-told for decades. It is one of the fastest growing startups to ever disrupt the market. The company transforms buildings into collaborative workspaces and provides infrastructure, services, events, and tech to its members. It’s a coworking startup. The show stars Jared Leto as Adam Neumann (Founder), Anne Hathaway as Rebekah Neumann (Wife & Co-Founder) and Kyle Marvin as Miguel McKelvey(Co-Founder). I highly recommend giving it a watch. It's an excellent series for binge-watching and offers insightful perspectives on the intricate and often challenging dynamics between venture capitalists and founders.

The story of WeWork, dramatized in the show, narrates the meteoric rise and dramatic fall of a company that once symbolized the epitome of startup success. Founded in 2010 by Adam Neumann and Miguel McKelvey, WeWork sought to revolutionize the way we work by providing shared workspaces to freelancers, startups, and businesses. Its innovative model attracted significant investment from investors like Benchmark Capital (early Uber investors), SoftBank, and JPMorgan Chase. WeWork grew at an alarming rate as they expanded globally. At its peak it was valued at $47 billion in 2019.

However, the company's aggressive growth was marred by financial mismanagement, questionable business practices, and leadership controversies, notably involving Neumann. The attempted IPO in 2019 exposed these issues to the public, resulting in Neumann stepping down and a dramatic devaluation. Despite efforts to stabilize, including a public listing via a SPAC merger, WeWork's operational and financial challenges persisted, ending in a bankruptcy filing in 2023. Below I include an insightful graph showing WeWork’s rise and fall.

The WeWork saga and Adam Neumann's story offer several lessons for investors and founders alike. For founders, the importance of sustainable growth, transparent governance, and maintaining a balance between innovation and operational viability are key takeaways. It highlights the risks of overvaluation based on hype rather than business fundamentals. For investors, due diligence, clear accountability mechanisms, and the potential pitfalls of charismatic leadership without a strong board presence (read last week’s post on boards!) Both parties can learn the value of aligning our expectations and the need for a solid (yet growing) business model that prioritizes long-term stability over rapid expansion.

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Ebbs & Flows 🌊

Venture funds, by nature, target returns significantly higher than public market indices due to the higher risks and illiquidity involved. Historical data from Cambridge Associates points to top quartile VC funds achieving annual returns between 15% to 27% over the past decade, a stark contrast to lower quartile funds and the broader market's average. This performance disparity underlines the venture world's high stakes, where the journey for outsized returns drives limited partners’ (LPs) investment strategies. As we navigate these economic currents, understanding these benchmarks and strategies for enhancing returns becomes crucial for both new and seasoned investors in the VC ecosystem.

When it comes to VC fund economics, it's crucial to grasp how investors gauge success through metrics like DPI and IRR. DPI, or Distributed to Paid-In ratio, measures capital returned to investors against their initial outlay, serving as a direct reflection of the fund's tangible returns. IRR, or Internal Rate of Return, offers insight into the annualized earnings rate on investments, capturing both the magnitude and timing of returns. To understand this concept, let’s go through an exercise. Which of the below two investments would you rather have?  

1) You get 4X your original investment in 2 years

2) You get 8X your original investment in 6 years

Many would jump for the 8X. But the most efficient investment is option 1, because you double your money every year. With investment 2, you are doubling your money every 2 years. The time and risk horizon on the second investment is longer, and, of course, so is the opportunity cost you would incur by tying your money up in it. This example shows you the importance of time when it comes to annual rates of investment returns.

Top-performing funds aim for a DPI of around 3x, indicating a tripling of invested capital over time, while maintaining robust IRR figures to demonstrate superior annual growth rates, illustrating the balance between long-term gain and efficient capital deployment.

The National Bureau of Economic Research has stated that a 25% return on a venture capital investment is the average. Most venture capitalists or venture capital returns will expect to at least receive this 25% return on investment. The public markets provide an annual average return of about 7%. So, for investors to invest in a risky asset class like early-stage startups they will need to be compensated - hence the average IRR of 25%. Below is a recent report from PitchBook that shows the tough year that VC funds have had (like we talked about last week).

Sources: (BIP Ventures), (PitchBook), (Seraf), (UpCounsel) (YahooFinance)

That wraps up this week! Thank you for supporting me for the past month. I am excited to continue to pursue this endeavor and to hone in my writing ability. If you are interested in understanding more about Venture Funds and the asset class - stay tuned! Looking to get involved in an angel group and start investing in startups? Reply to this email!

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