E124: Is Venture Capital Entirely Based on Luck? University of Chicago and Oxford Study

In this episode of the How I Invest Podcast, I interview David Clark, CIO of Vencap, to discuss the venture capital landscape. We discuss assumptions about small vs. large venture funds, unpack survivorship bias in performance data, and explore the power law dynamics in early-stage and growth funds. David Clark shares Vencap's strategy for identifying top-performing managers, insights on fund size limits, and the implications of political and economic shifts on venture capital. A must-listen for investors seeking a data-driven perspective on navigating the venture ecosystem.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00David Weisburd?

  One of the interesting characteristics of the venture asset class is this persistence of return. University of Chicago had the study that over half of funds that were in the top 25% continued to be in the top 25%. Have you found that to be the case and why is that the case?

• 0:15Speaker 01

  Yeah, we absolutely have. I know I've seen similar research from Tim Jenkinson at the University of Oxford. He said, I think the data he was looking at was Burgess data and he was seeing a 45% chance of having successive top quartile funds. And interestingly, there was also a similar chance of having consecutive fourth quartile funds as well. So it's not just at the top quartile where that persistence plays out, it's also at the bottom quartile. And I think it's worth just mentioning that, you know, when compared to private equity, that persistence of performance is much greater.

• 0:49David Weisburd?

  So David, you posted a really controversial post on LinkedIn implying that smaller venture managers may not actually outperform larger managers. Tell me a little bit about that.

• 0:59Speaker 01

  There definitely seems to be a common belief that smaller funds and emerging managers will outperform. And it feels like that that meme is being shared and repeated without too many people actually looking at the underlying data to see if it's backed up. So, you know, one of the things we always try and do at Vencap is to go to the the primary data source and see if actually the conclusions are justified from from the data. So this is data that we got from PitchBook. So they have data on about 14,000, 15,000 funds that were raised between 2010 and 2019.

• 1:41Speaker 01

  But there's only about 1,000 of those that where they have performance data. So, you know, first of all, you are working with a sample that is incredibly small. And then if you look at, you know, the sample by fund size, for that smallest fund size group, the zero to $199 million, there are only about 5% of the funds that raised where there's performance data. We're not saying that small funds don't, you know, can't perform well or large funds perform better. What we're saying is that that you can't really use the publicly available data to draw those sorts of conclusions.

• 2:21Speaker 01

  Because particularly in a power law asset class where, you know, you do have a small number of funds that that, you know, massively outperform. You know, you just don't know if those funds are being captured in the performance data that comes out. And certainly, when we look at our portfolio, the vast majority of the funds that we back are not captured in the publicly available data. That's on PitchBook. If you're thinking about basing your investment strategy off the fact that, well, everybody knows small funds outperform, you've got to be really careful about that because, you know, our view is it's just not supported by the underlying data.

• 3:04David Weisburd?

  For those listening on audio only, we have a graph on the screen based on PitchBook data that shows that zero to $99 million funds, only 5.1% have actually shared the data. And then 100 to 250 million, 13.9, 250 to 523%, and 500 to a billion, 29.7%. So essentially, half a billion to billion dollar funds are six times more likely to have shared their data on PitchBook.

• 3:35Speaker 01

  Yeah, I think that's, I think that's right.

• 3:38David Weisburd?

  And you believe this shows survivorship bias. What is survivorship bias?

• 3:42Speaker 01

  So survivorship bias is something that, you know, that we have to contend with in the venture industry because a lot of, a lot of the data sources, so PitchBook and certainly Cambridge rely on the managers themselves self-reporting their performance data. And so what you tend to find is that if a manager has a, has a really unsuccessful fund or poor performing fund, then that data tends not to get submitted. And certainly, if managers, you know, maybe raise one fund and then aren't able to raise any more, it's unlikely that they're going to continue to report their data into a Cambridge or a PitchBook. So what that ultimately does is overstate the performance in a lot of these instances

• 4:27Speaker 01

  because you only have the successful managers that are contributing their performance data into the, into the data set. So yeah, the whole survivorship bias is. Is a real challenge. The one thing that I think the one data set that doesn't suffer from that is Carter, because they are able to report all of the managers that raised funds using their platform. And so there's no survivorship bias there. The downside to the Carter data at the minute is that it only goes back five or six years. But as that data matures, that could be a really interesting source of a much more accurate truth about, you know, what VC

• 5:12Speaker 01

  performance looks like. Again, it's very much concentrated on smaller funds. So they don't have any of the really established manager funds on there. But certainly for that emerging smaller fund segment of the market, I think that's going to be a much better indicator of how those funds are actually performing in aggregate.

• 5:32David Weisburd?

  To use an analogy, we all have that one friend that goes to Vegas and always talks about how much money he wins, when in reality, he's only letting you know, maybe the 20% of times that he wins, or he wins one night, and then he loses the next night, and he only tells you about the wins. What are the consequences of potential survivorship bias in small funds?

• 5:54Speaker 01

  I remember someone once saying to me that the plural of anecdote isn't data. And so, you know, you need to, you hear a lot of anecdotes on, you know, I've heard people on podcasts like yours, David, will say that, you know, I invested in a fund that did 10x, and I invested in a fund that did, you know, 20x. And that's great, you know, it's great to have those funds in your portfolio. But but a single data point doesn't give you any real conclusions around whether an investment strategy is successful. You know, you have to look at things over the aggregates, and you have to look at things, not just at a particular point in time, but we would argue, you have to look at it across an entire cycle, because there may be certain types of strategies

• 6:39Speaker 01

  that outperform when the market's going up, but they might massively underperform as the market corrects. And in a way, we're seeing that a little bit at the minute.

• 6:47David Weisburd?

  You have data from Venkap going back to 1985, and you've seen many funds. Tell me about what you see in terms of the returns of growth funds. And is there also extreme outcomes in growth funds like we see in emerging managers?

• 7:03Speaker 01

  So I posted something on X a week or so ago, where we looked at the power law concentration of the growth funds that we've invested in. So, you know, in terms of how do we classify early versus growth? For us, you know, we don't really do pre-seed. There are, you know, we have a small number of seed funds. And then the early, so early would be categorized as those small number of seed funds, plus funds that are predominantly investing it around the sort of series A. And they'll do some B rounds into those. But if it's predominantly A rounds, we'll classify them as early. And then growth would be anything that's from B onwards. I would say the bulk of what we do would be kind of early growth.

• 7:48Speaker 01

  So it would be sort of Bs and Cs. And, you know, we've talked about this previously about what the power law looks like for for early-stage funds. You know, 60% of companies don't return capital. Around 1% of companies are ultimately fund returners. And it's those funds.

• 8:04David Weisburd?

  So 1%, so you invest in 100 companies. One of them will retire, then return the entire fund.

• 8:11Speaker 01

  Yeah, at least one times the entire fund. Very often it's multiples of the fund.

• 8:17Speaker 01

  And so that, you know, that's, that's the typical power law dynamic for, for an early-stage fund. We thought it would look very different for, for growth funds. Because of, again, because of the sense that, you know, growth funds are investing later, they're taking less risk. And, and so it would have something that resembled much more of a kind of private equity-type return distribution, where you got few companies that ultimately lost money, few companies that, that generated, you know, 10x or more. And, and most companies in that kind of fat middle that, you know, let's call it a sort of 2 to 5x. What was interesting, when we ran the numbers, it, it looked, it looked quite different to that.

• 9:00Speaker 01

  So even for the growth funds, they lost money on, on more than 40% of deals. So four in 10 deals, they wouldn't get their capital back, which, you know, was, was quite surprising, I think, for us. But it's also indicative of just how much risk is still involved in these companies, even at the B, C or D round. You know, you're not going into companies that, that are definitely going to make it. There's a high mortality rate, even for those types of businesses. And and the flip side of that was even more interesting for us because when we looked at at 10x, you know, companies that have generated a 10x for for early stage funds, it's about five and a half percent. For growth funds, it was just under that. You're still

• 9:44Speaker 01

  seeing that that real kind of concentration of returns in a relatively small number of of companies at the growth funds. And then we looked at fund returners, and and this was the thing where we really, really were shocked. So for early stage funds, we've said about 1% of their investments ultimately in funds that we've backed, 1% of their investments ultimately turn into fund returners. For growth funds, that's currently running at 1.6%. So we're seeing a higher incidence of fund returners for growth funds than we are for early stage funds. And and that was, you know, that was shocking.

• 10:23David Weisburd?

  You mentioned that your highest performing fund was actually a growth fund, not an early stage fund. Explain how that could be the case.

• 10:32Speaker 01

  Yeah, so so our best performing funds that we've invested in in that 2010 to 2019 sample size was a an $800 million growth fund. And it was able to and it's generating a 13 and a half x multiple. Now, again, I'm just throwing an anecdote out here. That doesn't that doesn't mean that this strategy works just because we've got one fund that's done particularly well. But I think it's interesting because I think, again, the general the general view is that, you know, you can't generate those sort of multiples on anything but a small emerging manager fund. And that is just absolutely not the case. So this

• 11:16Speaker 01

  fund was able to do it because it was a relatively early investor, you know, a B round investor in one of the largest companies that was founded in the last 15 years. The company is still private. It hasn't it hasn't it hasn't had an exit event. But but the manager has been able to take a little bit of money off the table on its investment, but it's it's still holding, you know, many multiples of the fund in terms of the unrealized value there.

• 11:48David Weisburd?

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• 12:32David Weisburd?

  Take a step back. You're Chief Investment Officer of Vencap. Tell me about Vencap and what is the Vencap strategy?

• 12:39Speaker 01

  Yeah, so Vencap has been investing in venture funds since the mid to late 1980s. And that's all we do. So we're 100% focused on venture. And over time, our strategy has evolved. So back in the day, we were similar to a lot of other investors out there in that we had a diversified portfolio, investing in 30, 40, 50 different managers. And what we found was that the aggregate returns from that strategy just didn't make sense. We weren't getting the outperformance that we wanted to see from the VC industry. But

• 13:21Speaker 01

  within that cohort of managers that we backed, we found there was a relatively small number that were consistently able to outperform. And by outperform, it really means hit that top quartile benchmark on a regular basis. And so we spent a bit of time trying to dig in and understand what was causing these managers to outperform. And what we found was when we looked at funds that had generated a 3X net return for us.

• 13:52Speaker 01

  At the early stage, ninety percent of them had at least one company that returned the entire fund. And so, you know, we really then started to focus on, okay, who are the managers that can, you know, back the very best companies and do so in a way that allows them to generate fund returning outcomes from those investments? And what we found is there's a relatively small number of managers that are that are able to do that consistently. So really, for the last fifteen years or so, our portfolio has been very concentrated into those managers. So, you know, ninety percent of the capital we've invested over the last decade has gone to twelve, thirteen managers. And, and, you know, we don't add

• 14:32Speaker 01

  a new manager very often because the the bar is is exceptionally high. Interestingly, we we added one earlier this year. That was the first new manager we've added to our core program in probably five or six years.

• 14:45David Weisburd?

  One of the interesting characteristics of the venture asset class is this persistence of return. University of Chicago had the study that over half of funds that were in the top twenty five percent continued to be in the top twenty five percent. Have you found that to be the case? And why is that the case?

• 15:02Speaker 01

  Yeah, we we absolutely have. I know I've I've seen similar research from Tim Jenkinson at the the University of Oxford, who who said, I think he the data he was looking at was Burgess data, and he was seeing a forty five percent chance of of having success of top quartile funds. And interestingly, there was also a similar chance of of of having consecutive fourth quartile funds as well. So it's not just at the top quartile where that persistence plays out, it's it's also at the bottom quartile. And I think it's worth just just mentioning that, you know, when compared to private equity, that persistence of performance is much greater. So in private equity, it's about a third, I think, of of funds that have, you know, if a manager has a top quartile fund, they'll go on to have

• 15:47Speaker 01

  a successor top quartile fund. So, you know, venture is is very is very different to private equity in in that respect. And I think ultimately, it comes down to the power law nature of the asset class. And and, you know, it was It was interesting. I was at Slush, you know, a week or two ago and talking to a lot of European managers, talking to a lot of US managers that were over. And one of the US managers, you know, said something that that really resonated with me. And it was almost a kind of lightbulb moment, which was the best founders can raise an infinite amount of capital from anybody they like. So why are they going to choose me?

• 16:29Speaker 01

  You know, first of all, to sort of see the deal and to be in the network of those founders. So, you know, I think that's a prerequisite for doing that. But why is it, you know, why is a world-class founder going to choose you as an investor? I think generally it's because, you know, they're looking at.

• 16:48David Weisburd?

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• 17:21Speaker 01

  What's the, what's the, like, do I want to work with you for the next 10 to 15 years? That's, that's one of them. So, you know, there is a, there is a personality thing there that, that, you know, if you're an absolute dick, then people aren't going to want to work with you. So I think, you know, you have to have a personality that, that is supportive of founders and makes founders want to spend time with you. I also think, you know, the, as a firm, you have to be able to, in a way, kind of add value to those companies that you're backing. And how do you do that? You know, one of the things we hear consistently is the best firms are able to lend their brand

• 18:02Speaker 01

  to the companies that they back. And that brand allows those companies to raise capital, to hire employees, to bring in customers. Not that the companies couldn't do that themselves, but the addition of that brand. You know, it's a real, it's really additive in their ability to do that.

• 18:23David Weisburd?

  Just to play devil's advocate.

• 18:26David Weisburd?

  You know, there's been this persistence of returns for many decades, but there's also been this discipline around venture fund size over many decades. First principles would say that as funds get much larger, those returns are going to get smaller. Why would that be the wrong way to think about it?

• 18:45Speaker 01

  Yeah, I think you have to look at the relationship between fund size and exit size. So if fund sizes increased disproportionately to exit sizes, then I would agree with you. I mentioned the quarterly review we did, you know, just looking over the last, you know, the last few months about, you know, some of the valuations that the best tech companies are able to raise capital at today with a view that, you know, there's going to be, by the time they ultimately exit, they could be worth, you know, multiples of that. I think that's really tying into our perspective, which is that, that the size of the best tech companies is only going to continue to increase.

• 19:27Speaker 01

  And so what you need to do is to compare the size of funds today with where we think the, the value of the best companies is going to be in 10 to 15 years' time when they ultimately exit.

• 19:38David Weisburd?

  Is there a fund size where you basically say, okay, guys, like, it's been a great relationship, but we can't back you in a $10, $20 billion fund?

• 19:48Speaker 01

  I think what we're seeing is, is from early stage, that the largest early stage funds we're seeing are probably these days around $1 billion, maybe a billion five. So what do you have to believe that for them to return $1 billion on a single investment? You know, they need to own 10% of a $10 billion company. You know, do we think that manager is capable of doing that? Well, the first question we look at is how often have they done that historically? And if they've done that multiple times historically, then that gives us much greater conviction on their ability to do it going forward. So I think it's not about, it's not necessarily about is there a fund size that that is too big?

• 20:32Speaker 01

  It's much more about what is the maximum fund size that we consensably underwrite a fund returner for this particular manager?

• 20:41David Weisburd?

  Tell me about the state of the venture market post 2024 election. What changes, if any, have happened in the space?

• 20:49Speaker 01

  I think it's really interesting, you know, that that people focus on on kind of short term events and thinking what's changing here like nothing's changed in a way, you know, in the long term, you know, for us ventures about, you know, can you get the best managers backing the best founders like that's what venture is all about and don't try and overcomplicate it and don't try and impose, you know, what might happen over the next four years into, you know, how that affects your long term strategy because I can guarantee you that Trump is not going to be president of the United States when companies that are founded today ultimately exit in 10 to 15 years time, at least I hope I can guarantee that.

• 21:33Speaker 01

  But so so I think I think you can get as an LP, you can get really sort of fixated on what's happening in the in the near term and lose sight of ultimately like how do you build a portfolio and a program that's going to deliver over the long term. And as I said, for us, it's about like just find those managers that can consistently back the very best founders. Now, having said that, clearly, we have seen, we have seen some changes in the in the market sentiment since since Trump was elected, you know, we do invest in a number of crypto funds and blockchain focused funds, you know, it feels as if there will be a much more sensible regulatory environment for those

• 22:16Speaker 01

  firms to operate in and for their portfolio companies to operate in, you know, Marc Andreessen was was very vocal on Joe Rogan recently.

• 22:26David Weisburd?

  Yeah, great episode, something everybody should watch.

• 22:30Speaker 01

  Yeah, yeah, it was it was brilliant. And and, you know, for those that haven't seen it yet and haven't seen the all the conversations on X, you know, they were, he was, he was highlighting the fact that the traditional banking system was effectively de-banking people that were in the crypto space. And we've seen this firsthand as well. With you know with our portfolio, how difficult it's been for for some of the the funds, the crypto funds to open bank accounts and what they have to go through. And some of the things they've been talking about with their portfolio companies. So so this is real and it and it does feel like that in that in that part of the market. You know, there there is going to be a much more sensible regulatory framework. I think for tech more broadly.

• 23:16Speaker 01

  You know, it it again, Mark Andreessen was talking about the

• 23:22Speaker 01

  the the regulatory environment that a lot of tech companies had to operate in, which was stifling innovation and stifling the ability to grow. It does feel as if that handbrake will be lifted when when the Trump administration comes in. You know, I think what we don't know is is what the sort of second and third order consequences of a Trump presidency are going to look like for the tech industry. Particularly if he becomes or if the US becomes, you know, more protectionist. If tariffs come into play. So I I think, you know, our sense generally is we feel in the short term, it could actually be a positive for the tech industry.

• 24:06Speaker 01

  But we we are kind of reserving our judgment on on ultimately what that will look like longer term until we see, you know, exactly which bits of of of policy they end up implementing.

• 24:20David Weisburd?

  I think there's a bit of a paradox when you think about politics or trying to play macro investor from one perspective, you want to be long the asset class from another perspective, you you want to be smart in how you allocate your investments. There's also, I think it's true, obviously, we're going to have a different administration, eight, 12, 16 years. But there is.

• 24:46David Weisburd?

  There is this reflexive nature to startups where they become self fulfilling. If suddenly, nobody is investing in crypto or nobody is investing in new AI companies, it becomes a self fulfilling prophecy. So sometimes, the prognostication on the future could actually affect even seed companies today.

• 25:04Speaker 01

  I think you have to understand where you are in the in the kind of food chain though. Is LPs, you know, I feel like an LP strategy is a little bit like an oil tanker. You know, you can't be navigating what's happening on a day to day basis. You know, you've got to set a course and take the volatility that's invariably going to come as you kind of play out your your investment strategy. And I think it's actually dangerous to try and jump around too much. Because, you know, again, our sense is that it's it's almost impossible to to time the market. It's almost impossible to pick, you know, individual verticals that are going to generate those next, you know, the next set of of top 1% companies for LPs.

• 25:49Speaker 01

  And so, you know, we would much rather take a view that we want to invest consistently. You know, we want to keep a fairly consistent annual investment pace. And we really want to focus on, as I said, those managers that are consistently able to back the top 1% founders and not try and not try and overthink it.

• 26:12David Weisburd?

  We've seen some of the greatest companies of all time started during recessions like Microsoft, Airbnb. What needs to happen for other LPs to become excited about the venture asset class again?

• 26:24Speaker 01

  I'm a bit of a contrarian by nature, so I get excited about the venture asset class when everybody hates it and everyone, it's really hard to raise capital. You know, that's that's what gets me excited. You know, I think if you're talking about more generalist investors, then, you know, historically, we clearly have seen a relationship between, you know, performance, the exit market and fundraising. So, you know, if you're asking what will it take for, you know, more dollars to be to come into the VC asset class? I think the answer there is, you know, we need to see that exit market open up. And again, you know, the the early indications we've seen over the last few weeks are that,

• 27:06Speaker 01

  you know, companies are starting to to have those discussions again. And and so I wouldn't be surprised if if we see 2025 as a much stronger year when it comes to to IPOs. And and then hopefully we can get some clarity on the on the M and A market as well. You know, clearly, we haven't seen much happening in in that space over the last over the last couple of years.

• 27:30David Weisburd?

  I'm curious, a lot of LPs are concerned that venture funds are marking their positions higher than they're actually worth. Looking back at Vencap's data going back to the 80s, have you found that TVPI, or where a venture fund marks its book, closely tracks DPI, which is actual capital returned back to investors?

• 27:52Speaker 01

  No, we haven't. So again, we looked at.

• 27:57David Weisburd?

  So the skepticism is warranted.

• 27:59Speaker 01

  Yeah, but again, I think so we looked at, you know, we looked at the data to say, how does how do you know, how does DPI or even TVPI in the F5? How does that correlate to where a fund will ultimately end up? And the answer is it's not really a great predictor. And and so, you know, the the early performance of a fund to us is is kind of irrelevant. And and what we need to see is evidence of of one of those, one or more, hopefully, of of those potential top 1% companies in the portfolio. And I think that's a much stronger signal for us than, you know, than than than

• 28:42Speaker 01

  early liquidity or, you know, early write-ups because, you know, you have to understand where you are in the cycle. Because it was, you know, we saw a lot of seed funds do exceptionally well in terms of getting those unrealized gains through 2019, 2021. And and interestingly, you know, we still see indications that.

• 29:05Speaker 01

  They are holding a lot of those companies at last round value, not at what they would be worth today. You know, in contrast, when we look at our established managers, they were probably pretty quick to write things down and and did so, you know, reasonably aggressively. Um, you know, it varies by manager to manager, you know, not everybody is is as conservative as as perhaps we would like them to be or to do it as quickly. Um, and and so, you know, what, but what I would say is it it feels as if we've gone through that wave, certainly with our managers now. Um, and we think that portfolios are possibly undervalued um on a on an aggregate basis.

• 29:46David Weisburd?

  How do people follow you online?

• 29:50Speaker 01

  Um, so I'm I'm on X, um, at at David Clark eighty five. Um, I'm also on LinkedIn as well, so um, it's a it's a mixture of of stuff. Um, some things I'll post on X, some things I'll post on LinkedIn, it kind of a slightly different different audience there. Um, so yeah, feel free to feel free to to follow me on on either of those. Um, you know, also, you know, Vencap um is is also active on on LinkedIn, so you know, follow us there. You know, we we try and we try and post things that are data driven because that's how we think of the of the VC industry, that's how we approach the VC industry.

• 30:31Speaker 01

  I think there's a lot of a people, there's a lot of people in in VC um that that, you know, tend to have strong opinions, but those opinions aren't necessarily backed by data. So, you know, we we prefer to.

• 30:44David Weisburd?

  Strong opinions loosely backed.

• 30:48Speaker 01

  As opposed to weakly held, yeah.

• 30:51David Weisburd?

  Yeah.

• 30:52Speaker 01

  Yeah, so I think for us, you know, we we we like, we like to, we like to to to have um, a very strong foundation of why we do things and and, you know, we recognize the data is not perfect and the data is backward looking. Um, and and, you know, there are reasons when, you know, we'll go against the data if we think it's it's not relevant moving forward. But but I think understanding the data. And and using it to to really push back on some of the the kind of common myths that are out there in the venture industry, I think is is really important for investors to do. You know, one of the things we say internally is is that, you know, when someone says, well, it's common knowledge that this is the case in venture, we say, well, common knowledge in

• 31:34Speaker 01

  venture is usually wrong. So, you know, don't just don't just take these assumptions at at firsthand, you need you need to you need to go and really examine the underlying data and understand what's driving it.

• 31:48David Weisburd?

  Well, David, it's been great to have you back on the podcast. I look forward to sitting down in New York or London very soon.

• 31:54Speaker 01

  Yeah, it sounds good. Brilliant. Thanks so much, David. That's been

• 31:57David Weisburd?

  Thank you, David.