Source: Yale Insights | Re-Post Boomerang Ventures 7/30/19
Most investing success is short lived. As the disclaimer goes, past performance does not guarantee future returns. But venture capital is an exception, with top VCs beating the average year after year. A new study co-authored by Yale SOM’s Olav Sorenson finds that consistent returns owe as much to a firm’s reputation and early luck as the smarts of its employees.
Read any of the many “best of” lists on venture capital and a handful of names will pop up again and again (and year after year): Sequoia, Kleiner Perkins, Benchmark Capital, Accel Partners, Tiger Capital. These are the firms that lead funding rounds for Silicon Valley unicorns, where partners become legends for inking deals with Facebook, Google, or Uber before most people had ever heard of them. When startup founders begin looking around for investors, they dream of landing one of these firms.
In recent years, big VC firms have been getting even bigger. Top firms gobble up more and more of available capital, leading to lean times for the “middle market.” Why? In a new study, Olav Sorenson, Frederick Frank ‘54 and Mary C. Tanner Professor of Management at Yale SOM, Ramana Nanda of Harvard University, and Sampsa Samil of the University of Navarra, find that the success rates of top firms flow from access to the best startups that is not available to newer or less prestigious firms. “There are a certain number of deals out there where you can just sort of see it —this is something that’s likely to succeed,” Sorensen says. “The problem is that everyone can see that. Everybody wants to invest in those deals. The ones that are able to make that investment are those that have a strong enough reputation that the entrepreneurs actually want them involved.”
If access is the key to a string of successes, what does a firm need to do to get to that point? Often one big deal is enough to establish a reputation as savvy investors. And how does a VC firm find such a startup? According to Sorenson, you need good luck. “That first fund ends up being almost a roll of the dice,” he says. “You take some chances on some really high-risk ventures. You hope that a couple of them pay off. If they do, then you start to develop this reputation. Then you’re able to get into the more attractive deals.”
n an interview with Yale Insights, Sorenson described what the findings mean for up-and-coming investors, fledgling entrepreneurs, and the industry as a whole.