Evaluating the performance of venture capital investments

Business Horizons, Sept-Oct, 1994 by W. Keith Schilit

One of the most successful investment advisers in the United States was recently asked his "formula" for successful investing. After a moment's thought, he replied, "Buy low, sell high." Venture capitalists strive for a target return for a given investment as well as for their overall investment portfolio. According to a recent study by the Joint Economic Committee (JEC), venture capital firms anticipated a minimum rate of return of 30 percent per year on an individual venture investment.

Is that a reasonable expectation? Do individual investments perform at or above that level? What returns can be expected for a "portfolio" of venture capital investments? In essence, do venture capitalists "buy low and sell high?" These are the questions addressed in this article.

PERFORMANCE OF SELECTED INVESTMENTS

There are numerous success stories of individual venture capital investments that give the appearance that venture capital funds, as a whole, perform remarkably well. For example, American Research and Development's (ARD) $70,000 investment in Digital Equipment Corporation (DEC) grew to more than $500 million in about 12 years, which translates into a compounded annual rate of return of more than 100 percent.

Some venture capitalists have a way of overstating the performance of companies in their investment portfolio. One even provided a "translation" list (see the Figure) to guide those who would heed venture capitalists' assertions. Nevertheless, the performance of several venture deals, as illustrated below, is noteworthy.

Success Stories of Venture Capital Firms

The investments made by our leading venture capital firms read like a who's who of successful emerging growth businesses. Some of their success stories are as follows.

Kleiner Perkins Caufield & Byers. Thomas Perkins entered the venture capital industry in 1966 with a $15,000 investment in University Laboratories, a Berkeley, California-based laser company. That investment grew to $2 million. In 1972, Perkins became a cofounder of the prominent San Francisco-based venture capital firm, Kleiner Perkins Caufield & Byers, which has invested in, among others, Genentech and Tandem Computer. Perkins has had an active involvement with his investments, having served as chairman of both Genentech and Tandem.

Sevin Rosen. Sevin Rosen Management, a venture capital firm founded by Benjamin M. Rosen, one of the most notable venture investors over the past 20 years, and L.J. Sevin, founder of Mostek, a semiconductor manufacturer, invested $2.1 million in Lotus Development, a software manufacturer located in Cambridge, Massachusetts. That investment grew to $70 million when Lotus went public in 1983. Sevin Rosen also invested $2.5 million in Compaq Computer, a Houston-based company whose first product was a portable computer. When Compaq went public in 1983, that investment was worth $40 million.

Arthur Rock. Arthur Rock's investments as a venture capitalist include: Fairchild Semiconductor in 1957, a pioneer in silicon chips; Teledyne in 1960, a multibillion-dollar, California-based conglomerate; Intel in 1968, a "chipmaker" that was an outgrowth of Fairchild Semiconductor; and Apple in 1978, a pioneer in the field of personal computers. Rock's investment in Apple grew from $57,400 to $13.2 million (a 200-fold increase) when Apple went public in 1980.

MIen & Co. Allen & Company is best known for its investment in Syntex, a small pharmaceutical company, in the late 1950s. Within a decade, when Syntex became one of the leading manufacturers of birth control pills in the world, Allen's $800,000 investment grew to more than $80 million. Allen & Company also invested in an early stage venture, Digital Switch, a developer of microswitching telecommunications equipment. This technology enabled MCI to become a major competitor of AT&T in the long-distance telephone market.

Hambrecht & Quist. Hambrecht & Quist, a venture capital firm that also provides such services as investment banking and underwriting of stock issues, is responsible for much of the growth of high-tech companies in Silicon Valley. Among the firm's notable investments are Apple Computer and VLSI.

TA Associates. TA Associates was formed by Peter Brooke as the venture capital arm of Tucker Anthony and RL Day, a Boston-based investment banking firm. It eventually became an independent venture capital partnership and is now one of the largest such firms in the country. TA Associates invested $1.7 million in Tandon Corporation between 1977 and 1980. By 1983, it had sold out its investment for $77 million. It also invested $171,000 in Biogen, a Boston-based biotechnology company, subsequently selling out of this investment with profit greater than $10 million.

Some others. Several other venture capital firms have had similar success stories. Sequoia Capital, for example, a Silicon Valley venture capital firm specializing in high-tech ventures, has invested in Atari, Apple, Tandem, Tandon, Altos Computer, LSI Logic, and 3 Com Corporation. Burr Egan Deleage & Co., a Boston-based venture capital firm with $250 million in paid-in capital, has invested in Triad, Tandon, Genentech, Tandem, Federal Express, and Chiron. The Mayfield Fund, a comparably sized Menlo Park, California-based venture capital firm, has invested in Amgen, Atari, Businessland, Compaq Computer, Genentech, and 3 Com Corporation. Institutional Venture Partners, also of Menlo Park, has invested a portion of its more than $200 million in committed capital in such companies as Borland International, Businessland, NBI, Seagate Technology, ROLM, Stratus Computer, and LSI Logic.