LP 101: Intro to investing in venture funds

I’ve had the opportunity to recently talk to a few folks who are considering investing in a venture fund for the first time. While there are lots of resources for new angel investors, I’ve found there isn’t as many for new LPs.

#OpenLP is a great movement to get the voice of LPs into the market, and Origins by Notation Capital is a great podcast where they interview LPs. I highly suggest both of these, and there are other great resources out there, but they seem to focus more on providing LP insight into VCs.

I thought I’d share some articles that might help those considering investing in a venture fund for the first time. By no means do I guarantee these are the best resources, but it’s a good start – and I’ll keep adding.

For those who are very unfamiliar with venture capital, 16 Definitions on the Economics of VC on A16Z’s blog is good to get familiar with some of the terminology.

I’d then dig into VC Funds 101: Understanding Venture Fund Structures, Team Compensation, Fund Metrics and Reporting, which covers… a lot of stuff, as it says in the title.

For understanding expectation as an LP, Funding Math by @homanyuen is a good article that provides some data point around expected returns as an LP, and the power law dynamic at play in the underlying portfolio. To summarize:

  • LPs want to see 2-5x return (6%-15% annualized) depending on stage of investments.
  • 65% of startup investments see 0-1x.
  • 10% of startup investments see 5x+.

This Twitter thread by Benedict Evans has some great graphs that go further into explaining the power law of returns at the portfolio level and their impact on fund returns. To summarize:

  • Across the board, about 6% of deals done produce 60% of the returns.
  • For the best performing funds (that do >5x), ~20% of their deals produce 10x returns, providing ~90% of the fund returns.

For those who want to dig in further on return expectations, this Twitter thread is a fairly biased thread that makes a great case on investing in venture capital. To summarize:

  • At the top quartile, VC has historically outperformed other asset classes (like PE, RE).
    • Note: VC is the most volatile, so this makes sense.
  • Even median funds in the 2009-2012 vintages are showing 9%-21% returns depending on vintage year.
  • VC has low top negative correlation with other major asset classes.
    • Specific to the S&P 500, VC returns have negative correlation.
  • On liquidity:
    • Avg time to M&A transaction: 5.5 years
    • Avg time to IPO: 8.5 years
    • Avg time to exit: 6.5 years

Slightly different, but if you want a better understanding of how many startups VCs meet before investing – while just one data point – Satya Patel at Homebrew was kind enough to share some of their metrics around this in their blog post: Homebrew’s 1%: The VC Metrics Behind Investing in One of Every 100 Companies We Meet.

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