Venture Capital is a bit like launching bottle rockets. I saw a statistic in Fortune Magazine last month that emphasized this. And as with anyone launching bottle rockets, each “venture guy” does it a little differently.
According to research by Cambridge Associates, featured in the December 1, 2014 issue of Fortune Magazine, Venture Capital has underperformed against the S&P by about 5% over a 5 year period. Venture Capital outperformed the S&P by about 5% over the 10 year period. Over a 20 year period however, Venture Capital has beat the S&P 500 by more than 24%.
For me, these statistics make me think of bottle rockets. I will admit that my brain is a little odd, but hear me out on this one.
Like bottle rockets, VCs go shopping for companies to invest in. Some look pretty bad and you know there will be several “duds” in the package, but they’re cheap and you can get a bunch of them often a buy one pack get two packs free deal.
Then there are the expensive bottle rockets. These are the big ones with the plastic (rather than curvy wood) stick extending from the plastic conical top of the bottle rocket through the massive engine. These are big, shiny, and expensive. They come in packs of one! You can drop your whole bank roll on just a few of these, but are they going to perform? Nobody really knows, but they look nice in a portfolio.
Then you have your standard bottle rockets. These come in a six pack. They’re moderately priced and seem to be adequately constructed. You never know how long this pack has been sitting on the shelf so you don’t know if you’re buying duds or studs, but history shows you’ll fair well with this pack.
The similarities between bottle rockets and possible investments in the venture world don’t stop at pure appearance and price, there is also the launch ability and the ultimate explosion to consider.
The launch is mostly up to the VC. Some like to place the rocket in a bottle (playing by the rules) and light the fuse. They stand back and close their eyes in hopes that the rocket is a good one and will scream straight up and explode into windfall profits.
Of course most don’t. Most shoot up a little and fizzle out, leaving you with a short, unentertaining show, which is why the S&P beats them over the 5 year average. In the last 5 years there have been some great Venture Funds, but most of them haven’t made much. They’ve had their duds, but their successes are yet to yield returns.
From the pack of rockets, whichever pack the VC has chosen, a few will perform fine. They go up in a spiraling organic pattern, they pop, they’re a success. These take a little longer to perform than the duds. These are the 10 year returns from Venture Capital that beat the S&P.
Keeping with the fireworks theme, we’ll call the S&P a pack of Black Cats. They’re a notable brand, moderately unpredictable, but they are rarely duds.
Over a 10 year horizon, we’ve had enough time for the Venture Capital successes to outshine the duds.
Then you have the very few bottle rockets that launch straight up, catch the wind just right, zoom into the stratosphere, pause for effect, then illuminate the sky with a spectacular finish (IPO). These are the spectacular bottle rockets we all hope for. These take the longest to develop, they’re the most rare, and they’re the one’s that make you hold your breath. These bottle rockets are the ones that give the Venture Capital industry such a big leg up over the S&P over the long term.
When you open to a 20 year horizon, you allow enough time to have the few spectacular bottle rockets show up in the result and really push the returns higher.
But all this talk about bottle rockets begs the question, can the launcher impact the trajectory of the rocket. Ben Feltner and I wasted our youths trying to exact the “Light and Launch” method (burning ourselves many times in the process).
We would hold the rocket in our hand pointing it toward the ground. We’d like the fuse, wait until just the right moment… then toss the rocket as high into the air as we could trying to time the apex of our toss with the exact moment the rocket would ignite. With this method we turned many a dud into a success. We turned many successes into spectacles, and threw a few spectacles into outright orbit.
We also burned ourselves, hit houses, cars, and almost my younger brother a few times. These are the crazy venture guys who like to get into the trenches with their founders. They fail with their duds, but they also launch a few into orbit.
There is nothing wrong with buying the expensive rockets or placing them in bottles. Many VCs have had much success this way. But we don’t like to buy the economy pack either and struggle through trying to get one or two to actually fly. We focus on the six pack variety and we get a little wild with them, risking a few burns for a few spectacular flights into orbit.