Does Venture Capital Pay? New Evidence on an Old Question

• Published date: 01 July 2015
• DOI: http://doi.org/10.1002/jcaf.22070
• Date: 01 July 2015
• Author: Luis E. Pereiro

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© 2015 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22070

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Does Venture Capital Pay? New

Evidence on an Old Question

Luis E. Pereiro

In the United States,

pension funds invest

close to 10% of their

equity holdings in ven-

ture capital. Among

households, the figure

climbs to a very sub-

stantial 45%. Do such

investments pay?1

To find out, inves-

tors must compare the

returns they realize

on such holdings with

a risk benchmark—a

minimum price, or compensa-

tion, that will be the reward

for the peculiar risks of invest-

ing in venture capital. Such

comparison is, alas, no simple

matter: in contrast to public

equity, venture capital is a

highly illiquid and hazardous

asset class, and we still lack

established models to properly

price its risk. Second, venture

capital is an opaque asset class,

for which data is hard to come

by and usually incomplete,

where assets are not priced con-

tinuously but episodically, and

reporting is subject to a fair

amount of discretion by the

funds’ general partners: ven-

ture capital defies the accurate

measurement of realized

returns.

We address the challenge

head-on by conducting a com-

prehensive review of the evi-

dence on realized U.S. venture

capital returns, which we next

compare with a novel suite of

risk benchmarks especially

suited to this highly special

asset class. Such comparison

unveils a stark, disquieting

asymmetry: whereas venture

capitalists do achieve a siz-

able risk-adjusted return, their

passive investors end up with

negligible excess returns—

simply because they are pay-

ing too large an intermedia-

tion fee.

THE REQUIRED

VENTURE CAPITAL

PREMIUM

Consider three

investors: X, Y, and

Z. X’s equity is

100% allocated to

a fund that tracks

a broad public

stock index, like

the Standard &

Poor’s 500 Index;

by definition, X is

a diversified investor. Assum-

ing a risk-free rate of 4% and a

required market risk premium

of 5%, X’s required return

on public equity would be

4%+5% = 9%.

Y’s equity is, in turn, 100%

invested in a fund that tracks

a broad venture capital (VC)

index, like the Cambridge

Associates (CA) Index. The CA

Index reflects the value of a

large number of minority posi-

tions in VC funds spanning sev-

eral industries. Consequently,

Y can also be considered a

diversified investor—but within

the VC market only. Finally,

Z is a venture capitalist whose

equity is 100% invested in a

Using a novel set of risk benchmarks, the author

analyzes the performance of U.S. venture capital.

Findings show, over the long term, that venture

capitalists have achieved a risk-adjusted return of

5.16%. In stark contrast, their passive capital pro-

viders have pocketed a dismal, close-to-nil return

on venture capital. The author suggests a method

to solve this imbalance—a practical way for pas-

sive investors to negotiate a fairer split of returns

with venture capitalists. © 2015 Wiley Periodicals, Inc.