We Have Met the Enemy And He is Us: Lessons from Twenty Years of the Kauffman Foundation’s Investments in Venture Capital Funds and the Triumph of Hope Over Experience

Over the past decade, public stock markets have outperformed the average venture capital fund and for 15 years, VC funds have failed to return to investors the significant amounts of cash invested, despite high-profile successes, including Google, Groupon and LinkedIn.

Interviews with fund managers and limited partners also suggest that many institutional investors commonly maintain inadequate fiduciary oversight and are anchored to narrative fallacies about the benefits of venture capital as an investment class. The report, “We Have Met the Enemy … and He is Us,” is based on a comprehensive analysis of the Kauffman Foundation’s more than 20 years of experience investing in nearly 100 VC funds. It illustrates a persistent pattern of inflated early returns in funds that may be used to raise subsequent funds and shows the poor historical performance of funds with more than $500 million in committed capital.

The authors call upon institutional investment committees to require deeper due diligence of VC investments and more rigorous data analysis of VC portfolio performance relative to the public markets. The authors also urge limited partner investors to charge more for providing capital to risk assets by insisting on preferred investment returns before sharing profits with general partners – as is often the practice with buyout and growth investment firms.

The authors also recommend that foundations, endowments, and corporate and state pension funds negotiate investment terms that better align their interests as limited partners with those of the general partners in which they invest.  The report suggests potentially troubling asymmetries between the information required by venture capital funds from portfolio companies and the information they are required to provide to limited partners of the funds.

The Foundation found that the most significant excess returns earned from venture capital occurred in funds raised prior to 1996, and those funds averaged $96 million in committed capital. Many of those successful funds led managers to raise successively larger funds; which significantly eroded returns and maximized general partner profits through fee-based income at the expense of limited partner success.

The report goes on to outline a series of steps the Kauffman Foundation itself will take to correct its approach to venture capital investing.