Split Between US and UK Venture Capital Funds Decreases

A new report by the National Endowment for Science, Technology and the Arts (NESTA) has found that the gap between US and UK venture capital funds has narrowed over the last decade.

(June 1, 2011) — A  new report has discovered that the performance gap in venture capital between the United States and the United Kingdom — once a significantly large divide — has gradually narrowed over the last decade.

The research by the National Endowment for Science, Technology and the Arts (NESTA), titled ‘Atlantic Drift: Venture Capital Performance in the UK and the US’, found that the reason for the convergence was largely due to average returns in the US declining rather than a noticeable improvement in the performance of UK funds.

“The convergence of returns has not been driven by UK funds becoming better, but by the worsening performance of US funds,” the report stated.

According to the research, the gap in fund returns between the average US and UK fund has fallen from over 20% before the dot-com bubble (funds raised in 1990-1997) to 1% afterwards (funds raised in 1998-2005). Furthermore, average returns for funds raised after the bubble in both the UK and the US have been relatively poor, but venture capital performance is likely to move upwards as venture capital funds begin to cash out their investments in social networks (particularly in the US). Thus, according to the author of the report, Josh Lerner of Harvard Business School, US funds — better positioned to profit from the emerging social media boom with generally superior investment opportunities — may forge increasingly ahead of UK funds in performance.

As outlined in NESTA’s research, the strongest quantifiable predictors of venture capital returns performance are (a) whether the fund managers’ prior funds outperform the market benchmark; (b) whether the fund invests in early rounds; (c) whether the fund managers have prior experience; and (d) whether the fund is optimally sized (neither too big nor too small). Moreover, historical performance has been higher for funds located in one of the four largest investor hubs (Silicon Valley, New York, Massachusetts and London) and for investments in information and communication technology.

In April, research from Dow Jones into private equity and venture capital fundraising also showed a divide between the US and UK. The research noted that while private equity and venture capital fundraising was up in the US, Europe experienced a slightly less optimistic fundraising environment.

“In 2010, many private equity firms focused on trying to return capital and those efforts are starting to bring their investors back to the party,” Laura Kreutzer, managing editor of Dow Jones Private Equity Analyst, said in a statement. “But limited partners are still like bouncers at an exclusive night club. They’re only letting the best looking groups behind the velvet rope. Everyone else still has to struggle for their attention.”

Dow Jones figures revealed that private equity funds in the US secured $31.6 billion for 89 funds during the first quarter, more than double the $13.5 billion raised for 81 funds during the same period last year. Meanwhile, the data showed that while European firms collected $8.2 billion during the quarter, up 39% from the $5.9 billion raised a year earlier, the number of closings declined to 22 from 32.

In the venture capital space, which has struggled to regain its peaks from the late 1990s and early 2000s, Dow Jones found that venture capital funds in the US raised $7.7 billion in the first quarter of 2011, nearly doubling the $3.9 billion raised in the same period last year and the highest first-quarter total since 2001. European venture firms, on the other hand, raised $653 million for five funds during the first quarter, down from $1.3 billion raised for 13 funds during the same period in 2010.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742