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Return Patterns of Venture Capital Investment Exits
For understanding how venture capital works, it is quite helpful to look at some of the larger-picture statistics about venture capital exits. Two of those I found in a 2001 working paper "The Risk and Return of Venture Capital" by John H. Cochrane from Chicago GSB, who had analyzed a sample of almost 17,000 venture capital financing rounds totaling more than $114bn.
The first such statistic deals with the probability of any given exit type as a function of the startup's age. It shows a pattern that is quite predictable with e.g. only about a quarter of startups still being private after 8 years. Or as Cochrane puts it:
By 5 years after the initial investment, about half of the rounds have gone public or been acquired. After this age, the chance of success decreases; more and more rounds go out of business, and the rate of going public or acquisition slows down.
Cumulative Exit Probabilities as a Function of Age
The second stat I have picked deals with an issue that is all too well-known: The homerun theory of venture capital. Only a few really successful investments can make a portfolio of dozens of investments successful overall, even if the majority of those investments fails to return anything or only returns modest amount. The following graphic gives a striking visualization of this issue, as it shows the distribution of percentage returns to be quite right-tailed -- and keep in mind: this graphic only deals with what one would generally call "successful exits", i.e. acquisitions or IPOs. Even among those successful exits, there is a significant homerun bias.
Most returns are modest, but there is a long right tail of extraordinarily good returns. 15% of the firms that go public or are acquired give a return greater than 1,000%! It is also interesting how many modest returns there are. About 15% of returns are less than 0, and 35% are less than 100%. An IPO or acquisition is not a guarantee of a huge return. In fact, the modal or "most probable" outcome in [this figure] is about a 25% return.
Smoothed Histogram of the Distribution of Percentage Returns for Firms that are Acquired or Go Public
And finally, the author compares VC investments with options, which is very fitting I find:
VC investments are very much like options. Volatility is good – it raises the chance of the large payoff, without greatly increasing the chance of a poor return. You can’t do worse than than lose your initial investment.
Disclaimer: Obviously, with the paper having been written in 2001 the current statistics might look different (especially the first one, I guess). The general patterns probably still hold true.