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View the full edition of Spotlight at: https://www.preqin.com/docs/newsletters/PE/Preqin Private Equity Spotlight July 2013.pdfFeature ArticleThe Venture Capital ConundrumDownload DataThe Venture Capital ConundrumInvestor appetite for venture capital funds remains high and new funds keep on being launched into the space.However, overall returns are low in comparison to other funds and there is a feeling that the industry won’t returnto the heyday of the 90s. Ignatius Fogarty looks to answer the venture capital conundrum and understand whatdrives investor appetite?Fig 1: Private Equity Horizon IRRs as of 31 December 201230%Annualized ReturnsVenture capital provides an important function in today’s economyin assisting the growth of new and young companies. The goal ofthe venture capitalist is to identify new companies that they feelhave potential and provide equity to these firms at an early stageof their existence, with the overall goal of growing these companiesand generating a return. There is the opportunity to make highreturns when investing in a venture capital fund, but there is alsothe opportunity to lose a significant amount of money as well. The1990s saw the venture capital industry attract significant publicity, asventure capitalists invested in internet start-up companies, but whenthe dot-com bubble burst many of these companies lost value veryquickly and folded. One of the most notable of these was Pets.com,which raised 82.5mn in an IPO in 2000, but folded nine monthslater. However, companies did survive the bubble and continue tothrive; one of these, Amazon.com, continues to be at the forefrontof e-commerce today.25%All PrivateEquity20%Buyout15%VentureCapital10%Fund ofFundsMezzanine5%0%1 Year toDec-20123 Years toDec-20125 Years toDec-201210 Years toDec-2012Source: Preqin Performance AnalystPerformance of Venture Capital FundsCompared to other private equity funds, venture capital funds asa group have more recently produced lower average returns forinvestors; Fig. 1 shows Preqin’s horizon IRR data. Ten-year horizonIRR data to 31st December 2012 indicates that for all strategies,private equity generated a return of 19.0% and for buyout fundsthis was 23.4%; however, venture capital funds only generated anaverage return of 4.4%.Investor Appetite for Venture CapitalDespite other private equity strategies recently outperformingventure capital, investor appetite for this fund type remains strongand fund managers are responding by launching new funds. As ofJuly 2013, there were 397 venture capital funds seeking to raiseFig. 2: Annual Venture Capital Fundraising, 2000 - 2013 YTD (As at 03July 2013)500461400Fig. 3: Proportion of Investors Planning to Make New Commitmentsto Venture Capital Funds in the Next 12 Months, 2010 - 2013No. of FundsClosed300 30025725225025222924911%H1 201128%229AggregateCapital Raised( bn)19920020%H2 2010358 349342300150H2 201122%H1 4792002100Investor appetite for venture capital funds has also increased overtime. Twenty-eight percent of the LPs Preqin spoke to for its InvestorOutlook: Private Equity, H1 2013 that are looking to make new fundcommitments in 2013, expected to commit to venture capital funds,as shown in Fig. 3. Furthermore, over 60% of investors tracked byPreqin’s Investor Intelligence online service have expressed aninterest in, or have previously invested in, a venture capital fund,which further demonstrates how widespread investor appetite forthis strategy is.H1 2010450350an aggregate 47bn in capital commitments. In 2012, 229 venturecapital funds held a final close, securing an aggregate 32bn frominvestors as displayed in Fig. 2.403213H2 201225%20122013 YTDYear of Final Close2011200820072006200120000H1 201328%0%5%10%15%20%25%30%Proportion of RespondentsSource: Preqin Funds in Market3 Private Equity Spotlight, July 2013Source: Preqin Investor Interviews, 2010 - 2013 2013 Preqin Ltd. www.preqin.com

View the full edition of Spotlight at: https://www.preqin.com/docs/newsletters/PE/Preqin Private Equity Spotlight July 2013.pdfFeature ArticleThe Venture Capital ConundrumFig 4. Venture Capital Net IRR Dispersion by Vintage YearDownload DataFig 5. Venture Capital - Minimum, Median and Maximum IRRs byVintage Year200%25%150%15%Net IRR since InceptionNet IRR since Inception20%10%5%0%-5%100%Maximum IRR50%Median IRR0%1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Minimum 50%Vintage YearVintage YearSource: Preqin Performance AnalystThe Big DrawSo what attracts investors to the venture capital industry whenit appears that, overall, the industry has not been performing aswell as other fund types such as buyout? Looking further into thenumbers, we can see that even though the overall benchmarkmay indicate that, as a group, venture capital funds may not haveperformed well, individually there are some great performing funds,which drives overall investor sentiment. Fig. 4 shows the IRRdispersion of venture capital funds, highlighting the difference inperformance of this fund type. The majority of funds are clusteredaround the median; however, there is the occasional fund thatperforms significantly higher than the rest. These are the “home runfunds” that drive investors to commit to venture capital funds.Fig. 5 compares the minimum, median and maximum IRRs of venturecapital funds by vintage year, illustrating the difference between thetop performing managers and the lowest performing fund managers.For funds with a 2005 vintage, the best performing venture capitalfund delivered its investors a return of 104.9%, whereas the worstSource: Preqin Performance Analystperforming fund generated a return of -36.5%. The best funds ofeach vintage year are performing very well; however, the worstperforming funds have negative IRRs, clearly demonstrating theimportance of selecting the best fund managers. Fig. 6 showsthe Preqin Venture Capital Benchmark and demonstrates that themajority of Q3 IRR quartiles are in the negative. In the 1990s theindustry was performing very well; looking at vintage 1997 funds,the median IRR was 29.8% and the maximum was 267.8%. Preqinhas identified over 164 venture capital funds with an IRR of over30%.Venture Capital ExitsIn recent years, venture capital exits have once again becomesignificant publicity events, the largest of which can be seen in Fig.7. When a tech start-up is exited by its founders, these individualsand their backers are celebrated widely, and stories of the growthof their personal wealth dominate not just the financial press, butthe mainstream media as well. The story of tech savvy studentsbuilding tech products in their dorm rooms, which then go on toFig. 6: Preqin Venture Capital BenchmarkMedian FundVintageNo. Funds2010IRR Quartiles (%)IRR Max/Min (%)Called (%)Dist (%) DPIValue anQ3MaxMinSource: Preqin Performance Analyst4Private Equity Spotlight, July 2013 2013 Preqin Ltd. www.preqin.com

View the full edition of Spotlight at: https://www.preqin.com/docs/newsletters/PE/Preqin Private Equity Spotlight July 2013.pdfFeature ArticleThe Venture Capital Conundrumbe companies worth billions of dollars, is this generation’s story ofthe self-made man. When Facebook issued its IPO, it was reportedthat Mark Zuckerburg’s personal wealth escalated to around 24bn,and those venture capital firms that had backed him from the startgenerated significant returns for their investors. Accel Partnersinvested in Facebook in 2005 and 2006 and now has approximatelya 10% stake in the company, which as of June 2013, is valued ataround 5.2bn. Instagram, another high profile tech start up, wasbought for 715mn by Facebook; it received funding from firmssuch as Andreessen Horowitz, Benchmark Capital and Greylock.There has been speculation recently in regards to Twitter, estimatedto be valued at 11bn, going public in 2014, which would generatesignificant returns for backers such as Benchmark Capital, CharlesRiver Ventures and Union Square Ventures. There is a view thatthe recent increase in investor appetite for venture capital has beendriven by these highly publicized events, which have made theasset class more attractive to investors. However, not all exits aresuccessful in the long run. Zynga’s share price has dropped by 75%since its IPO in 2011 and Groupon has had similar struggles, givingthe thought to many industry commentators that there potentiallycould be a “web 2.0” bubble in the not so distant future.Download DataConsistent PerformanceInvesting with a successful venture capital fund manager can deliveran investor high returns. An example is Union Square Ventures,one of the venture capital fund managers that provided financingto Twitter. All of the funds that it has raised historically are in thetop quartile for their respective vintage years, based on data fromPreqin’s Performance Analyst. Its first fund, Union Square Ventures,which has a 2004 vintage, significantly outperforms the benchmarkfor funds with the same vintge year. Other portfolio companies thatUnion Square Ventures has invested in include Tumblr (which in turnwas recently bought by Yahoo.com for 1.1bn in cash), Foursquareand Bluefin Labs.These successful fund managers are able to continually attractcapital from institutional investors for their vehicles. Insight VenturePartners, a firm which has four of its six funds in the top quartilein their respective vintage years, secured 2.57bn for its latestfund, Insight Venture Partners VIII, surpassing its target of 2.5bn.Among its investors were Washington State Investment Board andLos Angeles City Employees’ Retirement System.However, it is not just the high profile fund managers that cangenerate significant returns for their investors. Jerusalem Partners,Fig 7: Top 10 Venture Capital Exits by Exit Value, 2008 - 2013 YTD (As at 03 July 2013)InitialInvestmentDateInvestorsTotal KnownFunding( mn)Exit DateExitTypeExitValue( bn)Acquiror(Exit)FacebookSep-04Accel Partners, DST Global, Elevation Partners,Firsthand Capital Management, GeneralAtlantic, Goldman Sachs, Greylock Partners,GSV Capital, Hercules Technology GrowthCapital, Meritech Capital Partners, Microsoft, TRowe Price, The Founders Fund Management,TriplePoint Capital2,617May-12IPO16.0-InternetUSPharmasset, Inc.Jun-01Burrill & Company, CDIB BioScience VentureManagement, Horizon Technology FinanceCorporation, Lumira Capital, MPM Capital, aceuticalsUSSuccessFactors,Inc.May-06Canaan Partners, Cardinal Venture Capital,Emergence Capital Partners, GGV Capital,Greylock Partners, Lighthouse Capital Target, Inc.Jul-04Battery Ventures, Greenspring Associates,Insight Venture Partners, Scale VenturePartners, Technology Crossover tUS3PARdataJun-99AllianceBernstein, Amerindo InvestmentAdvisors, Integral Capital Partners, MayfieldFund, Menlo Ventures, Open Field Capital,Oracle Corporation, Oracle Venture Fund,Sun Microsystems, Van Wagoner CapitalManagement, Veritas Software, WorldviewTechnology eUSIsilon SystemsAug-01Atlas Venture, Focus Ventures, GGV Capital,Madrona Venture Group, Sequoia Capital,Tenaya Capital69Nov-10TradeSale2.3EMCSoftwareUSData DomainOct-02Greylock Partners, New Enterprise Associates,Sutter Hill Ventures26Jul-09TradeSale2.1EMCSoftwareUSKayak SoftwareCorporationJan-04Accel Partners, AOL Inc., General CatalystPartners, Gold Hill Capital, Lehman Brothers,Norwest Venture Partners, Oak InvestmentPartners, Sequoia Capital, Silicon Valley Bank,Trident SOmnitureMay-04Attractor Investment Management, HummerWinblad Venture Partners, Scale VenturePartners, rty DialysisApr-10Bain Capital, Ignition Venture Partners, KRGCapital-Aug-11TradeSale1.7FreseniusMedical CareAGHealthcareUSFirmPrimary Industry LocationSource: Preqin Venture Deals Analyst5Private Equity Spotlight, July 2013 2013 Preqin Ltd. www.preqin.com