It was interesting to watch the back and forth last week between the Wall Street Journal and Andreessen Horowitz about venture fund performance. The entire exchange seemed to miss entirely the reality of how LPs and founders value venture funds and the actual process by which funds aggregate and deploy capital.
The WSJ made the point that the A16Z funds trail the “top-tier” marked returns of funds like Sequoia, Benchmark, and Founders Fund. A16Z shot back, saying that you can’t compare across funds because they use different valuation methodologies in how they report illiquid, unrealized returns to investors. It also attacked the idea of calling marked unrealized gains “returns.”
The reality is that this debate is irrelevant to both LPs providing financing and founders taking it.
The debate between Andreessen Horowitz and the media last week over a WSJ article misses the reality that LPs don’t compare A16Z to Benchmark or other top tier firms on unrealized returns. Unlike public equities, LPs are limited in how much money top managers will take from them, and high returns are high returns.
Yes, venture funds share their unrealized returns to LPs while fundraising and LPs evaluate those returns against the overall market and other opportunities for their capital. But, within a wide margin of good expected or actual returns, the comparative returns of funds themselves don’t directly affect whether an LP puts money in a given fund. From an LP perspective, what matters is how many dollars a given fund or opportunity will let you invest, and what returns it can generate on your investment—not directly the comparison to other funds.
Benchmark, which is notable in that it doesn’t operate a suite of funds like many others but is basically a single venture fund, only raises a few hundred million dollars every few years. It might have spectacular returns on those dollars (no matter what methodology you use). But its strategy fundamentally limits how much capital it can deploy at any time.
And it very rarely accepts new investors.
This means even wealthy and well-connected individuals and institutions aren’t likely to get into the Benchmark fund. And if they are able to get an allocation, it isn’t going to be as big as they want it to be. It is perhaps true that if, as an LP, you could put all your dollars in Benchmark, maybe you would. But you can’t.
Contrast this with others. Sequoia runs many funds of different sizes, strategies and rates of return. Founders Fund has dramatically increased the dollars it manages over time, and A16Z has very rapidly sized up as well. Any firm that has different products has different strategies, capital capacity and rates of return in different tranches under a single brand. Any firm that runs a single large fund has allocations of capital within that fund with different expectations.
Looking at the aggregate numbers among a set of high performers misses the point for LPs. For LPs, access to putting dollars to work at extremely high rates of return is the scarce commodity. Generally, there is a tradeoff between how many dollars any strategy or fund can run and the rate of return it can provide.
In this respect, venture is just like the hedge fund world. There are plenty of strategies and small funds that can provide great returns on relatively small dollar amounts and some that can provide good returns on huge dollar amounts. But you can’t directly compare them.
Why Entrepreneurs Don’t Care
Because the Benchmark strategy limits the aggregate dollars they can deploy, it means even wealthy and well-connected individuals and institutions aren’t likely to get into the fund.
The other side of this is the entrepreneur side. In the private markets, the ability of funds to get into the best deals is critical to generating returns. The reality is, however, that in general the performance that a fund delivers to investors has little to do with how good a partner it is to entrepreneurs.
Sure, there is some positive signaling associated with being backed by a fund known for picking winners. What is much more important is whether the people you work with day to day are good and provide value, and whether the fund has relationships that can help you get something done in a pinch. Of course, capital is capital. So its willingness to fuel your company with inexpensive money is also pretty critical, and needless to say, is the tradeoff that a fund must manage against achieving returns for its LPs.
On the margin, no founder cares exactly what Sequoia’s returns are relative to Founder’s Fund or A16Z.
All About the Media
A16Z has done a masterful job marketing Silicon Valley broadly, and itself specifically, to LPs globally. It has gathered significant assets and invested in good companies like Airbnb. It looks to be on track to return to its LPs over time significantly more money than they put in, and certainly outpace most other money-making strategies available for the scale of dollars it is running. This is a good accomplishment.
Could A16Z run a smaller fund and generate higher IRRs with fewer dollars? Perhaps. So could a lot of people. Could other funds raise more money and deliver still solid but not quite so spectacular returns? The answer likely is also yes. Will LPs pull their money from A16Z because Benchmark’s unrealized paper returns are better? No way. Do entrepreneurs care about any of this? Not really.
The reason there was so much discussion of the WSJ article is that, more than other funds, A16Z has run a strategy of putting itself in the public eye beyond the traditional LP and founder stakeholders that matter. That means it may feel like it has a broader brand as “the best” to protect than others. But in practice when you dig in, no one is comparing Benchmark and A16Z directly on returns—except maybe the media.