The New Math the logic of small funds Josh Kopelman, managing partner of seed-stage venture fund First Round Capital,
is one of the best-known small-fund venture capitalists. He argues that “the math” of
The Bigger They Are…
Declining Returns for Bigger Funds According to a recent study, venture capital firms tend to stumble as they get bigger. Researchers at Harvard found that as VCs raise larger funds,
the large-fund venture capital model is broken. For a $400 million fund to gener-
ate a 20% annual return for investors, he says, its general partners must build several companies that will have at least $6 billion in combined market value. When you
consider how few companies have had billion-dollar exits recently, Kopelman reasons, “You sit there and say, ‘Holy [cow], that model doesn’t work.’”2
Considering that the valuation range for most start-ups acquired today is $20 million to $100 million, a small fund does make sense. Take Greycroft Partners, a VC
their returns increase initially—but
fund established in 2006 by Alan Patricof, cofounder of private equity powerhouse
only until their fund size reaches roughly $200 million. For funds larger than $500 million, perfor-
Apax Partners and an early investor in Apple, America Online and Office Depot.
Although he could have raised more, Patricof deliberately kept the fund small—only $75 million—so he could focus solely on financing early-stage digital-media com-
mance begins to decline.
4
panies. Greycroft invests $500,000 to $5 million in each start-up, and it can produce competitive returns at that level, whereas such a deal would be a loss for a larger fund. “You can actually make a nice venture return if you sell them for less than
$100 million; you just have to go in at the right price,” said Dana Settle, a partner at
Venture Fund Size and Predicted Returns
Greycroft.3
Source: Lerner, J., Leamon, A., Hardymon, F. 2011.
John W. Glynn, a founder of Glynn Capital Management and a professor at the
Darden School of Business, agrees. The optimum VC fund size, he believes, is be-
25%
tween $100 million and $250 million. “Anything bigger is tough to manage,” Glynn said. “You’re better off raising smaller funds more frequently on good results than raising funds in excess of $500 million.”
PREDICTED RELATIVE IRR
20%
15%
10%
5%
0% $10
$20
$50
$100
$200
$500
$1,000
VENTURE CAPITAL—FUND SIZE IN MILLIONS OF DOLLARS
2
Ante, S. 2009. “‘Super Angels’ Shake up Venture Capital.” Bloomberg BusinessWeek. http://www.businessweek.com/
magazine/content/09_22/b4133044585602.htm. (Accessed 12 March 2012.) 3
Miller, C.C. 2009. “Venture Capitalists Look for a Return to the ABCs.” The New York Times.
4
Lerner, J., Leamon, A., Hardymon, F. 2011. Private Equity, Venture Capital, and the Financing of Entrepreneurship:
The Power of Active Investing. New York: John Wiley & Sons.
2
Batten briefing financing innovation series