Venture-Capital Returns Rebound

VC firms enjoyed their best quarter since 2006, but companies may continue to have difficulty securing venture funding.

One day after LinkedIn’s smashing debut on the New York Stock Exchange, which left the social-networking company with a market value of $8.9 billion, venture capitalists are practically jumping up and down in hopes that one of their investments might be next to have a big payday. Initially valued at $4 billion, LinkedIn is seen as the harbinger of market interest in a slew of other social media-related firms, including Facebook, Groupon, and Zynga.

While it will take months to sort out how successful LinkedIn’s initial public offering is for investors, thanks to standard six-month lock-up periods in which investors cannot trade their shares, many venture-capital firms already have reasons to celebrate. According to figures released Wednesday by the National Venture Capital Assn. (NVCA) and Cambridge Associates, returns for venture funds showed sharp improvement in the last quarter of 2010 (the most recent period for which data is available) and for 2010 as a whole.

Fourth-quarter returns were 8.4%, up from 3.7% for the previous quarter and the highest for any quarter since 2006. One-year returns were 13.53%, mostly driven by higher returns (28.16%) for later-stage firms. That compares with an average 3% return in 2009 and a 20.9% average loss in 2008.

“We typically discount the one-year numbers, but for 2010, the data is actually starting to show the positive impact of an IPO market that is better — not great, but better — and a better acquisition market as well,” says Mark Heesen, chairman of the NVCA.

On the other hand, the 10-year benchmark, the standard by which most funds’ success is measured, was slightly negative, indicating a 1.98% loss. “That number will only get fixed with a more-robust IPO market,” says Michael Greeley, founder and general partner of Flybridge Capital Partners. “You would hope that investments made in the downstroke of the dot-com bubble would be improving, but I think they are overwhelmed by the market falling out of bed in 2008 and 2009.”

For 1-year and 10-year returns, VC funds struggled to beat indices of publicly held stocks, such as the Dow Jones Industrial Average, the Nasdaq Composite, and even those including smaller-cap companies, like the Russell 2000. For 2010, the DJIA returned 14.1%, the Nasdaq 16.9%, and the Russell 2000 26.9%. “You want to see returns that are at least two percentage points higher than what’s happening on the major indices,” says Heesen. “Otherwise, why take the additional risk?” Looking across 15- and 20-year time frames, however, VC returns were between two and five times the returns on those indices.

For CFOs, such data likely means that getting venture funding will continue to be hard. Limited partners are getting warier about where to put their money, and fewer VC firms are surviving, making it harder for any given company to get backing.

However, at least there is some hope that things will loosen up. “People should take comfort in these numbers,” says Greeley. “There are still some structural issues, but on balance, I think things are only getting better.”

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