NCPA - National Center for Policy Analysis

Adjusting Venture Capital Returns

January 3, 2002

Venture capital (VC) investments carry more risk than most investments in the broad public market and their returns are much more modest than commonly thought, according to researchers.

Estimates of the returns to VC investments can be highly misleading because they typically reflect only those firms that have initial public offerings or are acquired by another company. Those without good returns are more likely to stay private or go bankrupt.

Based on a sample of VC firms, after adjusting the selection bias to include firms that go bankrupt, researchers say the mean (average) return on VC investments was 57 percent per year through June 2000 -- still large but far less dramatic that the 700 percent mean that only counts companies that go public or are acquired. Extending the sample to include the NASDAQ decline and the wave of failed venture capital projects could lower mean return estimates.

Researchers also say:

  • While there are a few companies with astounding returns, a much larger fraction show modest returns.
  • About 15 percent of companies that go public or are acquired achieve returns greater than 1,000 percent -- yet 35 percent achieve returns below 35 percent, and 15 percent deliver negative returns.
  • Only very volatile investments can occasionally attain 1,000 percent returns.
  • The most probable return is only about 25 percent.

Typically, health/biotech investments did better than typical information technology (IT) investments, though the higher volatility for IT gives it a larger chance for occasional spectacular successes and thus a larger arithmetic mean return.

Source: Andrew Balls, "How High are VC Returns?" NBER Digest, May 2001; based on John Cochrane, "In The Risk and Return of Venture Capital," NBER Working Paper No. 8066, January 2001, National Bureau of Economic Research.

For NBER Digest article


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