Oct 28, 2019 | Techcelerate Ventures |
Analysis of UK VC Financial Returns October 2019 2 BRITISH BUSINESS BANK 3 ANALYSIS OF UK VC FINANCIAL RETURNS CONTENTS For these markets to work efficiently, information needs to be made available that is both transparent and accessible. That’s why the British Business Bank undertakes an extensive programme of research and analysis throughout the year, looking at both finance markets overall and, when required, specific asset classes. A lack of evidence demonstrating a strong track record of an asset class can restrict institutional investors from investing, reducing supply. Information on the historic performance of the UK’s Venture Capital (VC) industry, in particular, has not been fully transparent, contributing to a lack of such finance being available to high growth potential businesses. In our recent Future of Defined Contributions Pensions report, we committed to take specific action to support greater transparency for LP investors. This report draws together data from existing data sources including PitchBook and Preqin, and from our own programmes, to provide as comprehensive a picture as possible of the asset class and its performance. KEY FINDINGS UK VC should be an attractive option for both LP investors already investing in US VC, and LPs not currently invested in VC and considering both the US and UK. Our analysis shows: • that UK VC funds with a 2002-2006 vintage outperformed US VC funds of the same vintage in terms of their DPI and TVPI money multiples • that, from 2007 onwards, the performance of UK VC funds is comparable to the US, with UK performance only slightly lower than US funds of the same vintage • that UK VC funds share a similar distribution of returns compared to US funds, apart from a small number of top US funds that outperform significantly. DRAWING FROM OUR OWN EXPERIENCE The British Business Bank is the largest UK based LP investing in UK VC, having committed, since 2006, £1.5bn of investment into 67 funds through the Enterprise Capital Fund (ECF) programme and the more recent, British Patient Capital programme, established last year. British Patient Capital (BPC) invests on a commercial basis into VC funds targeted at UK scale-up companies. While it’s too early in the life of BPC to draw definitive conclusions, the outlook for future performance is promising, with early DPI multiples being identical to the wider market for funds of the same vintage. The pooled TVPI multiple for private sector LP investors in VC funds under our ECF programme is higher than the wider UK market, partly due to the ‘geared’ returns structure we offer. The overall performance of the funds the British Business Bank has invested in provides further specific evidence of the positive returns that can be generated by UK VC funds. This report is an important first step in improving VC financial returns data to help build investor confidence in the asset class. We will continue to work with the wider VC industry to improve data coverage and accuracy still further. In doing so, we aim to help more high-growth innovative businesses in the UK get the finance they need to become the global success stories of tomorrow. FOREWORD KEITH MORGAN, CEO OF BRITISH BUSINESS BANK The British Business Bank is the UK government’s business development bank. Established in November 2014, its mission is to make finance markets for smaller businesses work more effectively, enabling those businesses to prosper, grow and build UK economic activity. 3 FOREWORD 4 EXECUTIVE SUMMARY 8 INTRODUCTION 10 SECTION 1: VC FUND FINANCIAL RETURN METRICS 13 SECTION 2: SOURCES OF VC FUND FINANCIAL RETURNS INFORMATION 16 SECTION 3: VC FINANCIAL RETURNS ACROSS DIFFERENT DATA SOURCES 22 SECTION 4: LONG RUN VC FINANCIAL RETURNS 25 SECTION 5: VC FINANCIAL RETURNS ACROSS GEOGRAPHY 32 SECTION 6: BENCHMARKING BBB AND BPC VC FUND PERFORMANCE TO THE WIDER MARKET 34 SECTION 7: CONCLUSIONS 36 APPENDIX: METHODOLOGY 38 ACKNOWLEDGMENTS AND ENDNOTES 4 BRITISH BUSINESS BANK 5 ANALYSIS OF UK VC FINANCIAL RETURNS 2. MOST VC FUNDS DO NOT PUBLICLY DISCLOSE THEIR PERFORMANCE DATA The variability in reported UK and European VC financial returns is partly due to data providers capturing the financial performance data from a relatively low proportion of the total number of VC funds in the market. British Business Bank analysis of Preqin shows this data source captures the TVPI multiples for just 13% of Rest of Europe VC funds with a 2002-2017 vintage year. This means coverage is not representative of the wider population of funds and heavily dependent on the sample composition of funds included. Preqin captures TVPI multiples for 22% of UK VC funds, which is higher than the Rest of Europe coverage. US Freedom of Information (FOI) legislation requires US public pension funds to disclose the performance of their investments into VC funds. This means data providers tend to have more representative coverage of US VC funds, although coverage has declined over recent years. Preqin captures TVPI multiples for 21% of US funds with a 2002-2017 vintage. In order to increase fund coverage, the British Business Bank has combined fund level data from several commercial data sources including PitchBook and Preqin with performance data on the VC funds the Bank has invested in. This approach will help to reduce the uncertainty around UK fund performance by increasing the relative coverage of existing datasets. KEY FINDINGS 1. ESTIMATES OF THE FINANCIAL PERFORMANCE OF UK AND EUROPEAN VC FUNDS VARY SIGNIFICANTLY BETWEEN DATA SOURCES There are several data sources providing information on the financial returns generated by UK VC funds, including commercial data providers such as PitchBook and Preqin and organisations representing the VC industry such as the British Venture Capital Association (BVCA). However, these sources are not fully consistent and there are large variations in reported returns figures for identical vintage years. For instance, the reported pooled DPI multiple for UK based VC funds in the 2002-2013 vintage year cohort varies from 0.87 to 1.54, and the reported pooled TVPI multiple varies from 1.50 to 2.06. The wide variation in reported returns figures creates uncertainty on the actual level of performance. In contrast, reported US VC financial return multiples are more robust with different data providers showing substantially less variation in the performance of VC funds with the same vintage years. For instance, both PitchBook and Preqin show pooled DPI multiples of around 1.00 for 2002-2013 vintage funds and pooled TVPI multiples in the range of 1.60 to 1.73 for VC funds in the same vintage year cohort. This is also supported by published Cambridge Associates data which shows yearly trends in reported DPI and TVPI multiples for US based VC funds are within a similar range and follow consistent trends over time. EXECUTIVE SUMMARY Venture Capitalists provide funding to early-stage companies with the potential for high growth. Venture Capitalists usually invest through a Limited Partnership fund structure, raising funding from Limited Partners (LPs) such as pension funds and insurance companies who are themselves looking for a return on their capital. For institutional investors to invest in Venture Capital (VC) they require evidence that the asset class can generate sufficient financial returns to offset the higher levels of risk and illiquidity in VC compared to public markets. There is currently no existing data source that has complete coverage of all UK VC funds, with data sources having relatively low coverage of VC funds and the financial returns information not being fully verified. The British Business Bank has tried to overcome these issues by combining data from several commercial data sources such as PitchBook and Preqin, alongside data from funds the Bank has invested in, to provide a more comprehensive picture of VC financial returns in the UK. This report is compiled on a ‘best endeavours’ basis using the most reliable data available. We welcome comments and suggestions for ways in which UK VC financial returns data can be improved. The report focuses on financial returns using money multiple measures only, as these can be calculated consistently across different data sources: • Distribution to Paid-In capital (DPI): Realised fund returns as a percentage of the capital contributed. This directly measures the cash received from portfolio company exits. • Total Value to Paid-In capital (TVPI): Realised and unrealised fund returns as a percentage of the capital contributed. This includes the realised returns and the ‘book value’ of unrealised investments and is useful for assessing performance during the early part of a fund’s life. The report examines the financial performance of VC in isolation and does not try to compare VC performance against other asset classes or against wider Private Equity (PE). 6 BRITISH BUSINESS BANK 7 ANALYSIS OF UK VC FINANCIAL RETURNS BRITISH BUSINESS BANK RESPONSE The British Business Bank and BPC will seek to make available more aggregate level data on the financial performance of funds it has invested in, in order to build up our own track record, but also demonstrate that the UK VC market could be an attractive asset class for LP investors. The Bank has already committed to take action to support greater transparency for LP investors. Our recent ‘Future of Defined contributions pensions’ report3 stated ‘The British Business Bank will continue to take the lead in improving the quality and availability of UK industry-level data on historic returns, increasing the broader transparency of the asset class’. This report is a first step towards demonstrating our commitment to improving VC financial returns data by using existing available data. The Bank recognises the importance of accurate data to ensure current and future LPs can make an informed decision for investing in the VC asset class and looks forward to working with the wider VC industry to improve fund coverage and accuracy. 4. PERFORMANCE OF FUNDS THE BRITISH BUSINESS BANK HAS INVESTED IN PROVIDES ADDITIONAL EVIDENCE OF THE POSITIVE RETURNS GENERATED BY UK VC FUNDS The British Business Bank is the largest UK based LP investing in UK VC, giving the Bank access to verified financial returns information from the funds that it has invested in. The numbers presented in this report may differ to the financial returns reported in the British Business Bank and British Patient Capital (BPC) annual reports due to differences in fund coverage and time periods assessed.1 The British Business Bank has analysed the performance of the Enterprise Capital Fund (ECF) programme, which was established in 2006 to increase the amount of equity finance available to high growth innovate SMEs affected by the equity gap.2 For VC funds supported by the ECF programme in the 2006-2016 cohort, the pooled DPI multiple is 0.47 overall (0.50 for other LPs). The ECF pooled DPI multiple is lower than the wider UK VC market DPI of 0.77, which may reflect the earlier stage nature of these funds compared to the wider UK market, meaning realised returns take longer to achieve. VC funds within the ECF programme have a pooled TVPI multiple of 1.41 (1.78 for other LPs), which shows the ‘geared’ returns structure for private sector LP investors is working as returns are now higher than the wider UK VC market of 1.63 within the 2006-2016 cohort. This higher level of performance could make the ECF programme an attractive asset class for LP investors when considering UK VC. BPC is investing on a commercial basis into VC funds targeted at UK scale-up companies. For those VC funds BPC has invested in between 2013-2016, the pooled DPI multiple generated to date is 0.18 and this is identical to the wider UK VC market DPI for funds of the same vintage. Although, the BPC pooled TVPI multiple of 1.29 is slightly lower than the UK market benchmark of 1.40 for funds of the same vintage, the BPC median fund TVPI performance is 1.21. This is higher than the equivalent UK market figure of 1.18. It is too early in the life of BPC to draw meaningful conclusions concerning future performance as most BPC invested VC funds are too young to be included in the analysis. 3. UK VC RETURNS FOR FUNDS ESTABLISHED SINCE 2002 ARE CLOSE TO CURRENT AND HISTORIC US VC FUND PERFORMANCE It is widely perceived that US VC financial returns are consistently and substantially higher than UK VC financial returns, but analysis of data within this report suggests that this is not the case. In fact, UK VC funds with a 2002-2007 vintage outperformed US VC funds of the same vintage. UK funds within this vintage year cohort generated a pooled DPI of 1.95 compared to 1.04 for US funds. This is due to strong performance of UK funds within this cohort, but also due to the underperformance of US VC funds, possibly a result of the legacy of the dot-com bubble bursting. Moreover, the above-mentioned pooled DPI returns for UK VC funds are only slightly lower than the historical performance of US VC funds in the 1980’s and 1990’s. The average yearly pooled DPI multiple for US funds in the 1980’s was 2.22 and for funds established in the 1990’s the figure was 2.56. Although US VC funds generated very high financial returns (DPI multiples in excess of 4) in several vintage years during the mid-1990s (e.g. 1993 to 1996), these returns were not sustained over the entire 1980- 1999 time period. From 2007 onwards, the financial performance of UK VC funds is slightly lower than the US. UK pooled TVPI is 1.54 compared to 1.88 for US funds with 2007-2011 vintage. Whilst both UK DPI and TVPI pooled multiples are only 0.3 points lower than US funds, with the same 2007-2011 vintages, the median figures are much closer. Over the combined 2002-2011 vintage year cohort, performance of UK VC funds is slightly ahead of the US on both pooled DPI and TVPI measures, providing further evidence that UK VC performed relatively well over the whole decade. The UK has a similar fund distribution of TVPI returns as US funds, but the top performing US funds have substantially higher TVPI multiples than the top UK VC funds. This suggests that UK VC could be an attractive asset class for LPs considering investing in US VC. 8 BRITISH BUSINESS BANK 9 ANALYSIS OF UK VC FINANCIAL RETURNS This report aims to shed new light on the financial returns from investing in VC by examining existing VC data sources alongside information on the financial performance from the funds the Bank has invested in. The report does not compare the performance of VC against other asset classes or examine the financial returns from investing in wider PE. THE STRUCTURE OF THE REPORT IS BROKEN DOWN AS FOLLOWS: • Section 1 provides an overview of different metrics for measuring VC financial returns including IRR, money multiples (DPI and TVPI) and other metrics used within the VC industry. • Section 2 describes the different data sources that provide information on financial returns. • Section 3 compares reported financial returns across different data sources and investigates why these differences exist. • Section 4 then examines financial returns across time to identify common time periods in which to compare performance. An assessment of US VC returns in the 1980’s and 1990’s is also made in order to assess the potential long-term performance of this asset class from funds that are fully liquidated. • Section 5 provides an empirical comparison of the financial returns across the UK and US using a composite dataset that combines fund level data from Preqin, PitchBook and British Business Bank commitments into VC funds. • Section 6 assesses the performance of VC funds the British Business Bank and BPC has invested in and benchmarks them against the wider VC market for funds of a similar vintage. • Section 7 sets out conclusions and discusses next steps for improving financial returns data. Information on the methodology used to create the combined dataset can be found in the report’s appendix. • Long-time illiquid asset: The typical life cycle of an LP commitment into a VC fund is usually 10 years or more, and there are limited liquidity options for LP’s to withdraw their commitments if they change their minds or their circumstances change.10 The final performance of a fund is not known until the fund has fully exited all of its investments, which can take many years to occur. British Business Bank research11 shows that the average time from initial investment to IPO is 5.3 years for successful UK VC-backed companies. Fund managers often cannot wait until returns are fully realised to report them, as they are required to report progress to the fund investors (LPs) under the Limited Partnership Agreements (LPAs) and also are likely to be thinking about raising subsequent funds.12 This creates difficulty because active funds will have unrealised returns (the theoretical value of the equity stakes taken), and any reported return number must estimate the value of these assets. • Unrealised investments are difficult to value: This is especially the case when a substantial proportion of a fund’s portfolio is made up of pre-revenue companies with most of their value in intangible assets.13 Although funds follow and reference the International Private Equity and Venture Capital Board’s (IPEV) valuation guidelines, valuing equity stakes in non-listed companies involves an element of judgement.14 Company valuations can also change rapidly when the company’s circumstances change, for instance, when the company receives a major contract or the technology is proven to work. It is difficult to extrapolate 10 years of future cash flows to value a pre-revenue company when there are large amounts of market and technology risk. • Existence of a ‘J-curve’: PE is a long-term investment which, in the first few years, will normally show a decline in the Net Asset Value (NAV) before showing any significant uplift. This is often the effect of management fees being paid out, as well as the costs of initial capital being deployed into companies. Company failures become apparent more quickly, but company successes take longer to materialise. There are also complexities around classifying VC funds, when funds make deals across different investment stages including PE deals and issues around specifying the vintage year.15 other asset classes is important for signalling the value of investing in VC. There is a lack of robust information on VC financial returns at the individual investment level and at the fund level. This is holding back the wider asset class as without evidence of a strong track record of generating financial returns in line with the level of risk taken, institutional investors are wary of committing or increasing funding allocation to VC. Reliable data demonstrating high VC returns could help unlock greater institutional funding into this asset class. This in turn leads to greater VC fundraising and increased amounts of equity finance available to smaller businesses with high growth potential. Accurately measuring the returns of VC funds is very difficult because the data is known to be ‘subject to biases’.8 The nature of the VC industry amplifies these problems: • No requirement for VC funds to publicly disclose information: PE is by its nature ‘private’ with fewer requirements to make information available compared to investments made in public companies. VC investors are not required to disclose information to regulators about specific deals they make or the performance of those deals, so a comprehensive dataset with full industry coverage doesn’t exist. • Wide dispersion in industry performance: It is estimated that the top US VC firms make a disproportionate contribution to total industry returns.9 Therefore, omission of even a small number of these top VC funds can heavily affect the overall returns reported. INTRODUCTION Venture Capital (VC) is a type of Private Equity (PE) finance provided by investors into small early-stage companies with the potential for very high growth. Finance is provided in return for an equity stake in the business and investors generate a financial return (or profit) on their investment when they sell their stake through an Initial Public Offering (IPO), trade sale or secondary sale. VC-backed companies are unlikely to have positive cash flows, or even be generating any sales at the time of investment. It may therefore take many years until a company has developed its technology and market position to allow a VC investor to exit with a positive return. Given the technology and market risks facing early stage companies of this type, a high proportion of investments will not return their capital. For instance, data from one investor showed 65% of its VC investments failed to return their invested capital.4 If equity investors select the right deals, they can make very high returns from these investments. For example, Sequoia Capital (a US VC firm) generated approximately 50 times returns on its $60m investment into WhatsApp when it was acquired by Facebook in 2014.5 The VC model relies on a small number of successful investments to pay for the investments that fail, with 10 times returns being quoted as a starting target.6 It is widely recognised that the Pareto Principle applies to VC returns with 20% of investments bringing in 80% of returns, and 1% of investments often bringing in more revenue than the rest of a fund’s investments combined.7 The PE and VC industry has grown and matured substantially to become an established part of many institutional investors’ portfolios, with VC now recognised as a standalone asset class. Institutional investors are often looking to invest in long term growth asset classes, and VC funds achieve this with a typical life span of ten years or more. A history of generating good financial returns, both in absolute terms and relative terms compared to 10 BRITISH BUSINESS BANK 11 ANALYSIS OF UK VC FINANCIAL RETURNS MONEY MULTIPLES Multiples provide a relatively simple measure of an investor’s return on their invested capital, providing a cash-on-cash measure of how much investors are receiving back from the capital they have committed. Multiples are useful in that they show the scale of the returns but a key limitation is that the time value for money is completely ignored.19 A fund returning twice the invested amount will have the same multiple regardless of whether the return took two or ten years to materialise. Two multiples that are typically reported by funds are Distribution to Paid-In capital (DPI) and Total Value to Paid-In capital, but it is also useful to know the Residual Value to Paid-In Capital (RVPI) which is the difference between the two multiples: TVPI = DPI + RVPI Distribution to Paid-In capital (DPI): The ratio of cumulative distributions to LPs divided by the amount of capital contributed by the LPs. At the start of a fund’s life, this ratio will be zero due to there being no exits to date but will begin to increase as distributions (portfolio company exits) occur. When the DPI is equal to one the fund has broken even, as the money paid in is equal to money distributed. Any number above one indicates that the fund has paid out more than has been paid in, so that LP investors get more than their initial capital back. This measure is therefore useful at the later stages of a funds life as it is an actual measure of fund performance directly measuring cash received from exits. MODIFIED INTERNAL RATE OF RETURN (MIRR) Assuming a reinvestment rate equal to the fund’s cost of capital is a more reasonable assumption than using the same rate as the original investment and it is precisely for this reason that the Modified Internal Rate of Return (MIRR) has been developed.17 The MIRR uses a similar technique to IRR but assumes that positive cash flows are reinvested at the firm's cost of capital. The initial outlays are financed at the firm's financing cost rate, separate from the rate of return of the project, at which cash flows can be reinvested. It then calculates the rate of return by looking at all project cashflows, and accounts for the time value of money. As such, the MIRR is designed to more accurately reflect what is done with intermediary cash flows and give a more accurate picture of an investment’s profitability. However, re-investment rates are likely to vary for different investors, based on their investment opportunities. MIRRs should only be compared to other MIRRs calculated using the same re-investment rate. Therefore, VC organisations like Invest Europe, which represents the European VC industry, do not recommend using MIRR as a measure for fund managers reporting returns to their LP investors18 and MIRR does not appear to be widely used by the industry. SECTION 1: VC FUND FINANCIAL RETURN METRICS There are several ways to measure VC and PE financial returns. It is important to acknowledge that no single measurement represents the best way of measuring the performance of VC investments and deciding which measure to use is often context specific. When reporting the financial returns of their portfolios, fund managers and investors typically use the following types of measure: • Internal Rate of Return (IRR) • Modified Internal Rate of Return (MIRR) • Money multiples: - Distribution to Paid-In capital (DPI) - Residual Value to Paid-In capital (RVPI) - Total Value to Paid-In capital (TVPI) INTERNAL RATE OF RETURN (IRR) IRRs are widely used by the PE industry to measure returns because they offer a way of comparing two investments with irregular cash flow timings and sizes. The IRR represents the discount rate at which the Net Present Value (NPV) of an investments future cashflows is equal to zero. The IRR measure incorporates the time value of money, so that £100 of returns generated sooner is valued more than £100 realised in the future. Whilst this measure is useful, the fundamental issue of using the IRR in isolation is that it rewards quick exits in the early years. There is the potential for fund performance to be artificially improved by fund managers exiting their investments sooner, rather than the fund manager allowing the company to grow to maximise its value.16 This is because IRR implicitly assumes the intermediary cash flows generated by an investment are reinvested and return the same IRR as the original investment. This is unlikely to be realistic as it implies a fund immediately finds an equally profitable opportunity to reinvest in. 12 BRITISH BUSINESS BANK 13 ANALYSIS OF UK VC FINANCIAL RETURNS OTHER FACTORS There are large variations in performance between the top performing funds and the remaining funds. It is therefore useful to look at both the pooled mean and median fund return figures, alongside the upper and lower quartiles. The VC industry has a focus on benchmarking upper quartile funds but there is no universal method for choosing the reference period or specific reporting metric, which will fluctuate from year to year depending on the composition of funds included.24 Pooled Mean: The return for the total group of funds being analysed. This is calculated by aggregating the realised and unrealised values across all funds, which accounts for different fund sizes. This is the best measure for estimating total market returns as it includes the performance of all outlier funds. Median: The fiftieth percentile. The return of a fund in the middle of the ranking. This represents the return of a ‘typical fund’. Upper quartile: The return of the fund in the top 25th ranking. When all VC funds are considered, upper quartile fund performance is higher than the remaining three quarters of other funds. Another factor to consider when assessing financial return metrics is the impact of fees. Management fees allow the fund manager to meet their own operating costs, including salaries for the team and regulatory compliance. Carried interest fees relates to the fund manager’s performance-related share of realised profits from the fund. Management fees can be substantial. Most financial return metrics are reported net of fees (i.e. fees are deducted). Finally, it is also important to acknowledge money multiple returns are reported in nominal terms. This is an important consideration given LP’s commit capital over a long time period lasting more than 10 years, and the real value of distributed returns will be eroded by inflation. Residual Value to Paid-In capital (RVPI): The sum of cumulative net asset value of the investment, divided by the capital contributed by the LPs. It calculates the multiple of the investment that would be returned to investors if the unrealised assets were sold at current valuations. Valuation of early stage companies can be very difficult because of the inherent uncertainty surrounding the prospects of the company. However, the concept of ‘fair value’ is used to value the unrealised assets at each measurement date, with a number of recognised valuation techniques used.20 The ‘Book value’ of unrealised investments is useful for assessing performance during the early part of a funds life, but offers no guarantee on future performance as valuations can change over time due to changes in wider economic and market conditions. For instance, a high RVPI may be indicative of an inflated market versus an accurate representation of how much the portfolio can actually be sold for eventually.21 Globally, there are a number of well- known later stage unicorn businesses that have exited under their last private valuation round (known as a down -round). This will effectively lead to disappointed LP investors as the DPI does not match up to the projected RVPI.22 Total Value to Paid-In capital (TVPI): The sum of cumulative distributions to LPs and the net asset value of the investments, divided by the capital contributed by the LPs. It calculates what multiple of the investment would be returned to LP investors if the unrealised assets were sold at current valuations and added to distributions that have already been received. This is useful for assessing performance during the early part of a fund’s life, like the RVPI measure. While this can provide a more complete picture on the returns from the fund, it is significantly impacted by the valuation that is placed on the unrealised investments remaining in the fund, although the impact should reduce as the fund matures and investments are realised. Given this difference, many LPs rely on the TVPI measure earlier in the life of a fund and DPI measure towards the end of a fund’s life. Money multiples tend to be a more conservative measure than the IRR measure as a zero-rate of reinvestment is assumed for cash flows.23 SECTION 2: SOURCES OF VC FUND FINANCIAL RETURNS INFORMATION There are numerous data sources measuring VC financial returns. This section provides a short overview of the main types of data provider and a description of how they collect this information. Section 3 then provides a comparison of the reported financial returns across these different data sources. There are three main types of data sources providing information on VC market financial returns: • VC Associations • Commercial data providers: Named funds • Commercial data providers: Anonymised funds VC ASSOCIATIONS: There are numerous industry associations across the globe representing the interests of the PE and VC Industries, based on their membership which largely comprises of fund managers. These organisations often report the investment activity of their members as well as the financial performance. The British Venture Capital Association (BVCA) represents the interests of the UK VC and PE Industry.25 BVCA’s membership comprises of over 260 PE and VC fund managers. The BVCA, in conjunction with PwC and Capital Dynamics, undertakes an annual survey of its eligible members asking about the performance of the funds that they manage. To be eligible for inclusion the PE firm must be a full BVCA member, raise money from third-party investors and manage that money from the UK (although it may be invested elsewhere). BVCA members investing from their own balance sheet, quoted vehicles such as VCTs and listed PE are excluded from the fund returns. The BVCA annually publishes financial returns information through its Performance Measurement Survey.26 The report examines the performance of PE and VC funds and then benchmarks them against other asset classes. Overall, 86 fund managers (with a total of 629 funds under management) responded to the latest 2017 survey. Fund data is presented anonymously in pre-defined categories relating to vintage year. Whilst this provides useful segmentation of the data, it is not possible to disaggregate the data further. COMMERCIAL DATA PROVIDERS: NAMED FUNDS (E.G. PREQIN AND PITCHBOOK) Commercial data providers like Preqin and PitchBook primarily source information on the performance of funds from public filings by pension funds, Freedom Of Information (FOI) requests and voluntary disclosures by fund managers (General Partners-GPs) or LPs. 14 BRITISH BUSINESS BANK 15 ANALYSIS OF UK VC FINANCIAL RETURNS These data providers allow customised searches on the performance of individual funds or tightly specified groupings of funds, e.g. over specific vintage years and geography. There are several recognised issues which can affect the reliability of data sources relying on self-disclosure and FOI submissions for their information:27 1. A lot of the data relies on voluntary submissions from fund managers themselves. There may be incentives for fund managers to report returns when they are performing well, especially if the fund manager is trying to raise another fund, or to stop reporting if performance subsequently deteriorates. 2. Due to the reliance on disclosure from public pension funds, funds without pension fund investors may not be as well captured. This could potentially cause bias in the data if pension funds invest in funds with different characteristics to other types of institutional investor. European coverage is likely to be lower as this reporting requirement does not apply to European pension funds. 3. These datasets also publish reported IRRs/ multiples without the underlying cash flow data, which often makes it difficult to verify the accuracy of the reported figures. PREQIN: • Preqin is a provider of data and intelligence to the alternative assets industry including PE, real estate, hedge funds, infrastructure, private debt and natural resources. It collects a range of information including funds and fundraising, performance, fund managers, institutional investors, deals and fund terms. Preqin has financial returns data for 1,254 US and European VC and Growth Capital funds with a vintage year between 2002 and 2018. PITCHBOOK: • PitchBook is a source of information on global trends in PE and is widely used by the VC industry. PitchBook collects a wide range of data including deal-level information, fund performance, fundraising data and data relating to company exits. Pitchbook has financial returns data for 1,439 US and European VC and Growth Capital funds with a vintage year between 2002 and 2018. COMMERCIAL DATA PROVIDERS: ANONYMISED FUNDS (E.G. CAMBRIDGE ASSOCIATES, BURGISS AND EFRONT- PEVARA) These companies source information in slightly different ways to one another, but mainly through the services they provide to Limited Partners and General Partners. For instance, Cambridge Associates is a global investment firm that manages custom investment portfolios for its clients. Burgiss is a provider of investment decision support tools for private capital, and sources data through private disclosure by LPs. eFront is a software provider of end-to-end solutions for alternative investments. These data sources have less sampling biases compared to data providers which source their information through web scraping, regulatory and voluntary disclosures, but coverage is limited to funds included in the service provided. For instance, Cambridge Associates provides investment advisory services to endowments and foundations, which may have different investment strategies compared to the wider market.28 Due to restrictions placed on the subsequent use of the data by the funds and LPs submitting their data, financial returns information can only be accessed in aggregated anonymised form and so is not possible to identify individual funds or examine the data further. In many cases, it is not possible to undertake the analysis of funds based in the UK. For this reason, these datasets are not examined further as part of this report. OTHER SOURCES OF INFORMATION ON VC FINANCIAL RETURNS The British Business Bank is the largest UK based LP investor in UK VC.29 The Bank monitors the performance of the funds it has invested in by collecting information directly from fund managers. LP status ensures this information is fully verified and has full coverage of funds it has invested in. In line with the Bank’s role in addressing market failures in finance markets, the characteristics of funds invested in through the Enterprise Capital Fund (ECF) programme may differ to the wider UK VC market due to their focus on early stage market, smaller deals sizes affected by the equity gap and emerging fund managers. Since 2013, BPC through the Bank’s previous VC Catalyst programme has invested on commercial terms in VC funds targeting UK scale up companies.30 It is early days in the life of these funds, but a summary of performance to date compared to the wider VC market is included in Section 6. The European Investment Fund (EIF) is also a large investor in VC funds and has published information on the performance of its VC portfolio by vintage year and country.31 There are other sources of information on VC markets including Crunchbase32, Dealroom33 and Beauhurst.34 These provide information on VC deals, exits and investors, but currently do not provide information on VC fund returns. 16 BRITISH BUSINESS BANK 17 ANALYSIS OF UK VC FINANCIAL RETURNS 1.50 1.62 2.06 1.55 1.74 therefore may not be fully representative of the wider UK VC market. The BVCA data in the sample is only reported as of December 2017, whereas data from the other providers has been updated much more recently. It is notable that the BVCA pooled mean average is above the upper quartile fund performance, which could suggest the BVCA returns figures are influenced by a small number of highly successful larger funds. Drawing comparisons in performance between the British Business Bank backed funds and the PitchBook and Preqin reported multiples may also not be a fair comparison. Most of the British Business Bank supported funds within the 2002-2013 vintage year cohort are part of the ECF programme,37 which is predominately targeted at addressing market failures affecting early stage companies, through investment in emerging fund managers. As a result, the funds in this sample are therefore likely to be smaller than the wider VC market and targeting companies at an earlier stage of development. Also, since the ECF programme only started in 2006 the British Business Bank portfolio within this sample is weighted to the later vintage years (2006- 2013).38 This could adversely affect reported performance as the fund managers in the British Business Bank cohort will have had less time on average to exit their investments. SECTION 3: VC FINANCIAL RETURNS ACROSS DIFFERENT DATA SOURCES There is uncertainty on the actual performance of UK VC funds due to the large variation between different data sources in the reported VC return for the same vintage years. This makes it difficult for institutional investors to assess the track record of the asset class. Figures 1 and 2 show the pooled average, median average and the upper/ lower quartile DPI and TVPI multiples for UK VC funds within a 2002-2013 vintage year cohort. This time period was selected to be consistent with the data reported in the latest full BVCA Measurement Report.35 Reported pooled average DPI multiples for the 2002-2013 vintage cohort of UK-based VC funds vary between data sources from 0.87 to 1.54, whilst reported pooled TVPI multiples for the same cohort vary from 1.50 to 2.06.36 Commercial datasets like PitchBook and Preqin tend to report higher fund financial returns for the UK when compared to published BVCA numbers and British Business Bank programmes. This could be a result of fund selection bias with good performing funds having a higher propensity to disclose their data to PitchBook and Preqin, or poorer performing funds choosing to not publicly disclose their financial returns. The BVCA data may also differ because coverage reflects its membership. BVCA includes the names of the fund managers responding to its survey, which mainly comprises of established fund managers, and FIG 1 COMPARISON OF UK VC 2002-2013 VINTAGE YEAR DPI FUND PERFORMANCE BY DATA SOURCE Source: British Business Bank analysis of PitchBook, Preqin and BBB MI data Lower Quartile Lower Quartile Upper Quartile Upper Quartile Median Median Pooled Pooled 1.40 1.60 1.80 DPI1.20 1.00 0.80 0.60 0.40 0.20 0.00 n=84 n=37 n=35 n=14 n=63 BVCA PitchBook Preqin BBB (ECF & BPC) Combined (PitchBook, Preqin & BBB) 0.87 0.90 1.54 0.67 1.03 FIG 2 COMPARISON OF UK VC 2002-2013 VINTAGE YEAR TVPI FUND PERFORMANCE BY DATA SOURCE Source: British Business Bank analysis of BVCA, PitchBook, Preqin and BBB MI data 2.50 TVPI1.50 2.00 1.00 0.50 0.00 n=84 n=37 n=35 n=14 n=63 BVCA PitchBook Preqin BBB (ECF & BPC) Combined (PitchBook, Preqin & BBB) 18 BRITISH BUSINESS BANK 19 ANALYSIS OF UK VC FINANCIAL RETURNS Only a small number of the funds the British Business Bank has invested in provide data to PitchBook or Preqin on their financial returns. The Bank has compared the performance of individual funds it has invested in, against the data these funds have reported to PitchBook or Preqin in order to assess the reliability of the self-reported data. In most cases, the reported figures are comparable to the ones recorded under the Bank’s MI system with only small differences, suggesting these commercial data sources give a reliable indication of fund performance. Reported DPI multiples in commercial data providers generally lie within 0.05 points of the figures reported in the Bank’s MI data and the pooled TVPI generally lie within 0.40 points of the figures the Bank holds on fund performance. Differences may exist due to timing, LPs investing at first or second close and possible exchange rate effects but there is no evidence of these funds systematically reporting higher returns to commercial data providers. However, for a very small number of funds the reported figures are substantially different, the reasons for which cannot be explained by simply looking at the data.39 This analysis therefore suggests the underlying quality of reported returns from named fund databases is of sufficient quality to draw conclusions at the market level. A comparison is also made between PitchBook and Preqin for the US and Rest of Europe for the same cohort of funds with vintage years 2002-2013.40 Figure 3 shows the reported PitchBook and Preqin financial return multiples for the US are very similar to one another. TVPI multiples for US funds in this cohort are 1.73 and 1.60 for PitchBook and Preqin respectively. Pooled DPI is also very close at 1.02 for PitchBook and 1.01 for Preqin. This provides reassurance that the US VC returns reported by PitchBook and Preqin are an accurate reflection of VC performance in the US. Figures 4 and 5 further examines the accuracy of PitchBook and Preqin’s reported figures by comparing them to Cambridge Associates data for the equivalent vintage years.41 All three data sources show similar yearly trends in their reported TVPI and DPI multiples. FIG 3 COMPARISON OF US VC 2002-2013 VINTAGE YEAR FUND PERFORMANCE BY DATA SOURCE Source: British Business Bank analysis of PitchBook and Preqin 2.50 Multiple2.00 1.50 1.00 0.50 0.00 n=453 DPI TVPI n=489 n=453 n=489 PitchBook PitchBook Preqin Preqin 1.02 1.01 1.73 1.60 FIG 4 COMPARISON OF US VC 2002-2017 VINTAGE YEAR POOLED DPI FUND PERFORMANCE BY DATA SOURCE Source: British Business Bank analysis of PitchBook, Preqin and Cambridge Associates PitchBook PitchBook Preqin Preqin Cambridge Associates Cambridge Associates 1.80 Pooled DPI1.40 1.60 0.80 1.00 1.20 0.60 0.20 0.40 0.00 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 FIG 5 COMPARISON OF US VC 2002-2017 VINTAGE YEAR POOLED TVPI FUND PERFORMANCE BY DATA SOURCES Source: British Business Bank analysis of PitchBook, Preqin and Cambridge Associates 4.00 Pooled TVPI3.00 3.50 2.50 2.00 0.50 1.00 1.50 0.00 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Lower Quartile Upper Quartile Median Pooled 20 BRITISH BUSINESS BANK 21 ANALYSIS OF UK VC FINANCIAL RETURNS Whilst there is little variation in reported DPI and TVPI multiples for US VC funds, the reported money multiple performance figures for funds based in the Rest of Europe (i.e. excluding the UK) show considerable variation. Figure 6 shows PitchBook gives an estimated pooled DPI multiple of 1.20 for Rest of Europe VC funds compared to 0.76 for Preqin over the same 2002-2013 vintage year cohort. Figure 6 also shows differences exist in the reported pooled TVPI multiple with PitchBook reporting a multiple of 1.80, and Preqin reports a multiple of 1.52. We are not aware of any other published sources of information on European VC returns that can be used to verify the figures, but the large range in reported performance multiples creates uncertainty around the actual level of performance for Rest of Europe VC funds.42 EXPLAINING THESE DIFFERENCES One reason for the divergence in the reported Rest of Europe returns figures between different data providers is the low propensity of VC funds and LPs disclosing their financial returns. Low coverage increases uncertainty around the actual level of financial returns as the sample of funds submitting returns data may not be representative of the wider fund population. US Freedom Of Information (FOI) legislation requires US public pension funds to disclose the performance of their investments into VC funds. For example, the California Public Employees’s Retirement System (Calpers) publicly publishes fund level performance on its website of all the PE funds it has invested in, covering a total of 253 funds.43 This means data providers tend to have more representative coverage of US VC funds. Whilst, the UK has no explicit legal obligation for public pension LPs to disclose performance data, the UK generally benefits from an open disclosure culture in order to promote the market and attract private institutional investors. Comparing the number of VC funds with disclosed TVPI multiples in Preqin to the overall reported population of VC funds for each vintage year shows the relative coverage of funds disclosing data. Figure 7 shows Preqin captures the TVPI information of just 13% of the Rest of Europe VC funds with 2002-2017 vintage year. Coverage is likely to not be representative of the wider population of VC funds and heavily dependent on the composition of funds included in the sample.44 A higher proportion of US funds (21%) disclose TVPI multiples, but Figure 8 shows the proportion has fallen over time.45 As a result, Preqin now captures financial returns information for a higher proportion of UK VC funds (22%) than the US over 2002-2017 vintage years. The decline in coverage for US VC funds since 2002 is also evident when looking at PitchBook data. Further analysis reveals it does not appear to be as a result of declining participation by public pension funds in US VC. A possible explanation is that since the financial crisis US fund managers and LPs have become less willing to disclose financial returns information, especially in the early part of a fund’s life.46 The low proportion of funds reporting financial returns information relative to the population of VC funds in the market is common across all VC datasets and leads to increased uncertainty around the actual financial returns. FOI legislation in the US may help contribute to a more representative sample of US funds providing data. The relatively low proportion of VC funds disclosing financial returns information provides strong justification for combining fund level data from different data sources to increase coverage, so that the sample of funds included is more representative of the wider population of VC funds. Fund level data on the performance of VC funds from Preqin and PitchBook was combined with data from the British Business Bank to create a composite dataset. This allows a more reliable assessment of VC returns to be made across different time periods and geographies. Funds appearing more than once were removed from the combine
UK VC should be an attractive option for both LP investors already investing in US VC, and LPs not currently invested in VC and considering both the US and UK. Our analysis shows: • that UK VC funds with a 2002-2006 vintage outperformed US VC funds of the same vintage in terms of their DPI and TVPI money multiples • that, from 2007 onwards, the performance of UK VC funds is comparable to the US, with UK performance only slightly lower than US funds of the same vintage • that UK VC funds share a similar distribution of returns compared to US funds, apart from a small number of top US funds that outperform significantly.
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