In Venture Capital, Size Does Matter

Silicon Valley Bank recently published a report that questioned whether smaller venture capital funds outperform bigger ones. Highlights of the findings include:

• Small Funds Have a Better Performance Profile than Large Funds with Seven Times as Many Funds Achieving a 3x and Greater TVPI (total value to paid-in capital) Multiple
• Among the Funds in SVB’s Portfolio of Investments that Outperformed their Respective Cambridge Associates Benchmark, Small Funds Fared the Best, Surpassing the Benchmark by Over 50 percent in Many Cases
• Fund Sizes Have Declined Since 2007, largely due to the reduction in raised funds after the 2001 dot.com bubble burst; and again after the 2008 downturn
• Small Funds Have a Better DPI (Distribution-to-Paid-in) Profile than Large Funds
• Ten Year Returns for Venture Have Fallen 32 Percent in One Year

The most compelling reasons cited for the better performance of smaller funds were:

• Leverage specialized industry expertise: smaller funds are not compelled by the need to deploy large amounts of funds… which reduces the need to expand beyond a core segment or portfolio company stage. By focusing on a core segment, the fund is able to achieve a higher level of expertise within that segment… and in turn be able to demonstrate a competitive advantage within it.
• Better alignment with investors: smaller fund GP compensation tends to be much more driven by carry (profit based compensation) than management fees. This creates a more direct alignment between LP needs (reduced fees and increased profits) and GPs.
• Fewer homeruns are needed to return the fund: Smaller fund sizes, and hence fewer investments, force managers to focus on capital efficiency. Capital-efficient businesses have a lower risk profile and a higher probability of returning at least the invested capital. More on this here.
• Ability to complement large funds: I’m not too sure about this one. The report positions smaller funds as ones that are relied upon by larger funds for syndications that leverage the former’s expertise.

Needless to say, we at OpenView Venture Partners have designed our firm to specifically leverage the advantages of small VC funds. We have limited our fund sizes to the range of $100-$150M (note SVB’s finding that the $100-$200M range has the highest return.) We have extreme focus on expansion stage software companies. We have allocated a significant portion of our management fees towards OpenView Labs as a means delivering operational value-add while further limiting our expense-based compensation.