Venture Capital: From Dead to a Trillion Dollars
You can still find articles talking about the death of venture capital, but it is becoming harder to write them without sounding silly. During the last 10 years, while venture capital was supposedly dying, the venture-backed companies that went public or got acquired in that decade achieved a combined valuation of $1.25 trillion as of Dec. 31, 2013. Even in the context of the overall U.S. economy, this is real money.
During the decade from January 2004 to December 2013 there were a total of 824 venture-capital-backed exits, valued at $100 million or above. Of this total, 145 are valued today (if public), or were valued upon acquisition, at $1 billion dollars or above. The total value of all exits was $1.23 trillion, and the value of just the top 145 was $1.01 trillion (all numbers as of Dec. 31, 2013). The 80 percent/20 percent rule holds strong.
Of the 145 billion-dollar exits, 107, or 74 percent, were in information technology, 25 in health care, and 13 in all other categories from cleantech to retail. However, IT accounted for 86 percent of the value, as the average IT exit was larger. The Top 10 exits are shown in the table below, and this links to the complete list of 145.
Within IT’s 107 billion-dollar exits, there were 29 companies focused on the consumer, primarily in the consumer Internet; 69 focused on selling to the enterprise; and nine semiconductor or component companies. However, those 29 consumer Internet companies created $637B of value, which was 73 percent of the total value created. There is a huge winner-takes-most phenomenon in the consumer Internet, and the combination of this, plus the overall size of the markets, has driven huge outcomes.
Software, Marc Andreessen tells us, is eating the world. In looking at the last decade, the part of the world that software has been munching on is clearly advertising. Ad-supported Internet businesses such as Google, Facebook, Twitter and LinkedIn have created $598B of value in the past decade. In a world where overall advertising spend is only growing at five percent, that value has to come out of someone’s hide, and it shows up in the death struggles in the newspaper business, the consolidation in the ad agency business, the struggles in radio, and even the slowdown in revenue growth for TV.
Within the enterprise market, the exits divide pretty evenly between 34 companies focused on line-of-business applications, all but two of which were SaaS applications, and 35 companies focused on infrastructure IT, evenly divided between software & services companies and hardware providers.
Outside of IT, health care saw 23 exits, and the “other” category saw 13, including some of the more interesting “huh, who would have guessed it” outcomes. Tesla is the obvious No. 1 company, but the list includes Under Armour, Ulta Salon and SolarCity. The fact that Elon Musk played a central role in two of these exits, and almost certainly will add SpaceX to the list, is one of those phenomena that cannot be predicted, merely marveled at. The big miss here, relative to the dollars invested, is cleantech or, more broadly, energy. Outside of the Internet, the other large value-creation event of the last decade has been shale gas, which has transformed the energy industry, but with almost no investments from, and hence no returns to, the venture industry.
Much of the value is created after the IPO. The value of this same portfolio upon exit was $464 billion versus a value today of $1.23 trillion. Sequoia Capital says on its website, “never sell before the IPO, never sell at the IPO, never sell just after the IPO.” While this is probably impractical as a rule, it is undoubtedly the value-maximizing option, as the few home runs swamp the many so so outcomes. There are also some really interesting “corner case” outcomes. Pharmasset was worth just $140M upon IPO, but sold 4.5 years later for $11B.
Much of the value was created in the past year. A year ago, we calculated the value of the 2003 to 2012 exits at $752B. New exits in 2013 added $94B but the run-up in the stock market raised the value of the earlier exits to $1.13 trillion. Venture capital is cyclical; the returns don’t come linearly over time, but like buses, returns tend to come all at once. As a result, you know nothing about anything in a business like this until you have lived through a cycle.
Exits follow a power law. Intuitively, we know that there will be lots of small exits, a few medium-sized ones and, very rarely, a huge one. However, it is possible to be more precise than that. Like a surprisingly large number of economic and physical phenomena, the number of exits and the size of those exits conform to a (rough) power law. The best way to see that mathematically is a graph of the log of the number of exits to the log of the size of those exits. Here is the graph, and as predicted, it is a straight line, all the way down to 100M.
Another way of describing a power law (again, simplifying somewhat) is the 80/20 rule, which clearly applies here at every level. Looking at overall exits, 82 percent of the value comes from the 18 percent of exits above $1 billion. Even within the $1B category, 80 percent of the total value of the 141 billion-dollar exits comes from the top 20 percent of those exits. Even more starkly, 30 percent of the value comes from Google alone. This is an absolutely predictable result, and one found across the board in economics. However, it is worth noting how disturbing the result is for someone working in the venture business. The second-best athlete in a race will probably lose by a split second, the second-best investment in the last 10 years is worth just a third of the best one, and the fifth-best investment (LinkedIn) was worth just a tenth of Google.
I have stared at these numbers for years, and this is probably my most personal important conclusion. Envy is a corrosive emotion, so don’t try and judge success as an investor as “being No. 1.” From a return perspective, No. 1 “whups” No. 2, who in turn leaves No. 3 in the dust. However, there have been hundreds of companies in the past 10 years that have made excellent returns for their investors, while making a difference in the wider world. Invest in teams whose mission you believe in, insist on excellence, and the returns will be just fine.
I have blogged on other occasions about the returns to the venture industry as measured directly by benchmarks and IRRs. This is meant to be additive to but separate from that discussion. I agree that the creation of $1 trillion of value is not “proof” that venture returns can be compelling, though I would argue that it is a very strong hint. What it does show is that even in the past decade, innovation and value creation have continued, and about five percent of the value of the overall U.S. economy (the total market capitalization of U.S. companies is $20 billion) can be attributed directly to brand-new companies, recently funded by venture capital. Venture matters.
Rory O’Driscoll is a partner at Scale Venture Partners, a firm investing in early-in-revenue technology companies in SaaS, cloud, mobile and Internet sectors. He sits on the boards of Axcient, Bill.com, Box, Chef, DataSift, DocuSign, Livescribe and Vantage Media. Reach him @rodriscoll.