LPs gripe that VC returns are too concentrated

Returns from venture investments have lagged behind other asset classes, and profits have been overly concentrated among a few leading funds, limited partners told a gathering of VCs at the National Venture Capital Association’s April conference in Washington, D.C.

During the panel discussion, five LP representatives laid out a list of criticisms aimed at the venture industry and called for changes in the way VCs account for performance of their funds and portfolio companies.

“We’ve seen a lot of changes, and not all of them for the good [in regards to venture industry performance over the past several years],” said Diana Frazier, a former VC and co-founder of $2 billion FLAG Capital Management. Frazier referred to a “stunning concentration of returns” as a key concern, and she noted that 32 leading managers provided an outsize share of returns for the entire venture industry over the past several years.

Industry data about venture returns paints an overly positive picture of recent performance, panelists said. One of the reasons is that venture-backed companies commonly receive large late stage investments prior to an exit. When they go public or are acquired, ownership in the portfolio is so diluted that the exits don’t provide the home run return that LPs expected from their GP’s early stage investments.

Over the past few years, returns to venture investors have actually been negative, said Eric Doppstadt, senior manager of private equity investments at the Ford Foundation.

“There’s a disconnect between industry data, and you just have to do the homework,” said Don Pascal of Commonfund. Pascal said he’d like to see VCs provide LPs more detailed information about portfolio company performance, either broken down by company or in aggregate form, that looks at revenue and which startups are close to breaking even.

Dixon Doll, general partner of the VC firm DCM, asked the panel of LPs if an annual performance number would be useful in evaluating VC funds. Doppstadt rejected the idea. Given that venture investments are multi-year positions, annual performance was not seen as a useful metric.

Limited partners were more conciliatory to venture capitalists on another front: the fees charged by top-performing funds. “We don’t mind paying the high fees for performance,” Pascal said, so long as interests of fund managers and LPs are aligned. In fact, anything less might be met with suspicion.

“It’s a Groucho Marx problem,” said Doppstadt. “If there’s a fund you can negotiate terms with, it’s probably a fund you don’t want to invest in.” —Joanna Glasner