The Diversifying World of Venture Capital

The ever-dynamic asset class is not for the weak or those with short-term views, research has shown.

Winning venture capital investments are no longer controlled by a handful of top managers, according to Cambridge Associates.

Thanks to a maturing industry and evolving markets for technology and health care, a diverse group of new and emerging venture capital managers are creating value for limited partners, the report said.

The consulting firm’s data revealed an average of 83 companies each year generated value in the top 100 venture capital investments from 1995 to 2012.

Furthermore, investments ranked below the top 10 deals earned an average of 60% of the total gains per year after the tech bubble, the report found. This is a sharp contrast to the pre-2000 period, Cambridge Associates continued, during which the top 10 investments generated an average of 57% of total gains.

“While much is being said about unicorns, defined as venture-backed companies that achieve a $1 billion valuation, investors should stay in vigilant pursuit of those managers making venture investments that deliver substantial total gains on the valuations they have paid,” the report said.

The composition of managers is also changing, according to the report.

While Silicon Valley firms continue to invest in the top 100 investments, emerging managers claimed 40% to 70% of total gains over the last 10 years, “a clear signal to investors to maintain more constant exposure to this cohort.”

Managers with smaller funds—less than $500 million—have also accounted for at least 50% of the total gains in the winning investments since 2005, the report said.

These changes in the venture capital markets may necessitate firms and managers to be just as dynamic and entrepreneurial to survive.

“Venture firms can no longer simply compete on capital alone; entrepreneurs today have options and venture capital is not the cottage industry it once was,” the report said.

Cambridge Associates warned that only institutions with long time horizons and the ability to withstand negative returns should dive into venture capital.

“This is not appropriate for investors with short-term performance objectives, or those not comfortable with spending both time and money over many years to understand the ever-changing opportunity that is venture capital,” it said.

Cambridge VCSource: Cambridge Associates “Venture Capital Disrupts Itself: Breaking the Concentration Curse”

Related: The Argument for Private Equity & The Most Consistent Names in Alternatives

By Sage Um