Did VC Fund Size Cuts Work?

[UPDATED] Coller Capital last week released a survey of limited partners, in which 65% of respondents said that they expect VC fund terms to become more LP-friendly over the next two years. This was portrayed by some as a sea change in the LP/GP power dynamic, although I suggested that “LPs would have more credibility if they began insisting on changes to funds that have already been raised.”

My dissent was rooted in the memory of late 2001 and early 2002, when LPs fought back against the obesity of VC funds raised during the dotcom bubble. Sixteen U.S.-focused venture capital firms “volunteered” to cut their fund sizes by an aggregate of nearly $4.5 billion, including brand names like Accel Partners, Battery Ventures and Kleiner Perkins. The argument for such cuts – which were technically agreements not to call down a certain percentage of committed capital – was twofold: (a) Valuations and investment opportunities had fallen post-bubble, so less money was needed; and (b) VC firms tend to perform better when they focus on earlier (read: smaller) investments, so this was a return to successful knitting.

LPs were happy with the resulting management fee reductions, and GPs were happy that their LPs were happy (butter ‘em up for the next fundraise). All hunky dory, except we’ve never actually looked to see if fund reductions produced better returns. So let’s do that now:

I have obtained 12/31/08 IRRs for 15 of the 16 funds that cut their size, via a variety of sources (public filings, conversations with LPs and research provider Preqin). These funds are: Accel Partners VIII, Atlas Venture VI, Austin Ventures VIII, Bay Partners X, Battery Ventures VI, Charles River Ventures XI, Kleiner Perkins X, MDV VII (which was being “annexed” at last check), Mobius Venture Capital VI, Redpoint Ventures II, Pacven Walden Ventures V, Sevin Rosen Funds VIII, Trident Capital V, Trinity Ventures VIII and Worldview Technology Partners IV.

I was unable to obtain 12/31/08 IRRs for Meritech Capital Partners II, so did not include it in my calculations. [Note: This post originally used just 13 of the 16 funds, but I obtained IRRs this morning for Kleiner X and Pacven Walden V and recalculated]

What I found was a mixed bag. The 2000 vintage of “reduced funds” easily outperformed industry benchmarks from both Cambridge Associates and Venture Economics. The 2001, on the other hand, did not. Here is data for the 2000 VC vintage, from which nine of the reduced funds came:

Mean IRRs for 2000 vintage
Reduced Funds: -1.33%
Cambridge Associates: -1.39%
Venture Economics: -2.1%

Median IRRs for 2000 vintage
Reduced Funds: 1.7%
Cambridge Associates: -3.37%
Venture Economics: -2.9%

The best performing of the 2000 “cut” class was Charles River Ventures XI, with a 9.93% IRR (according to Mass PRIM). The worst was Sevin Rosen Funds VIII with a -25.2% IRR (according to CalPERS).

Now here’s data for the 2001 vintage, which had six reduced funds with available IRRs:

Mean IRRs for 2001 vintage
Reduced Funds: -4.88%
Cambridge Associates: 0.49%
Venture Economics: 1.3%

Median IRRs for 2001 vintage
Reduced Funds: -6.65%
Cambridge Associates: 1.07%
Venture Economics: -0.10%

The best performer in this class was Austin Ventures VIII with a 3.2% (according to CalPERS), while the worst was Bay Partners X with a -11.2% IRR (also according to CalPERS).

I’m not a huge fan of fence-straddling, so I combined the mean IRRs for the 2000 and 2001 vintages:

Mean IRRs for 2000 & 2001 vintage
Reduced Funds: -2.75%
Cambridge Associates: -0.91%
Venture Economics: -1.04%

In other words, the average “reduced” VC fund underperformed VC funds as a whole (both cut and uncut). This isn’t to say that these particular funds would have performed better (or worse) had they stayed pat, but simply to say that the act of fund size reduction, on its own, did not spark outperformance.

The median IRR for the reduced funds was 1.2%, but I couldn’t make a benchmark calculation out of the publicly available Cambridge or VX data. Now feel free to rip apart my calculations…