Thinking About Thinking

The Law of Large Numbers

Posted in Venture Capital by larrycheng on November 9, 2009

There have been a number of great venture-backed acquisitions recently, and WSJ.com does a great job outlining the Top 10 acquisitions that have closed this year.  Here they are:

  1. Zappos ($847M)
  2. CoreValve ($700M)
  3. Pure Digital ($590M)
  4. Visiogen ($400M)
  5. SpringSource ($362M)
  6. BBN Technologies ($350M)
  7. Evalve ($320M)
  8. Ablation Frontiers ($225M)
  9. Mint Software ($170M)
  10. PayCycle ($170M)

Let me revise the list to add in a few more things.  The list below includes deals that have been announced and not closed (AdMob, Playfish, RueLaLa).  It also gives 100% credit for all earnouts ($300M+).  And, it gives credit to Zappos for Amazon’s stock appreciation (an additional $300M+).  Let’s consider this the fully loaded list.  Here’s how the top 10 will look:

  1. Zappos ($1,200M)
  2. AdMob ($750M)
  3. CoreValve ($700M)
  4. Pure Digital ($590M)
  5. Playfish ($400M)
  6. Visiogen ($400M)
  7. SpringSource ($362M)
  8. BBN Technologies ($350M)
  9. RueLaLa ($350M)
  10. Evalve ($320M)

In aggregate, this is a whopping $5.4 billion in exit proceeds when you take the top 10 acquisitions this year.  Most of these companies probably took investments from venture funds from the 2002–2006 vintage, when a typical large VC fund might be $750M.  Now let’s say this fictional $750M venture fund invested in all of these companies – yes, one VC firm investing in every top 10 acquisition in 2009.  And, let’s go further and say this VC firm got a very healthy 20% ownership in every single company.  Since I’m being so generous, let me do one thing that is not so generous, which is presume these exits represent all the exits in the fund.  Here’s what you’d get with some basic math:

That would lead to $1,084 million in gross proceeds back to this fictional large VC firm.  Now let’s net out 2% fees over 10 years (to keep numbers simple) – that leads to $934 million of net proceeds.  That’s a 1.25x net cash on cash multiple after getting the top 10 acquisitions in 2009. 

Now, let’s presume a fictional small $100M VC firm made a bunch of bets and owned 20% of AdMob.  And, let’s say they lost money on everything else in their portfolio.  That would be a $150M gross return and $130M net of fees.  That’s a 1.3x net cash on cash multiple from one great exit.  

The fictional small VC firm made a better cash on cash return for its LPs through one winner, than the large VC firm could accomplish by getting all top 10 winners.  That’s the law of large numbers in effect. 

11 Responses

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  1. PK said, on November 10, 2009 at 11:54 am

    Omniture by Adobe?

    • larrycheng said, on November 10, 2009 at 12:23 pm

      I figure Omniture was public for quite awhile before being acquired, so I didn’t count it. VCs could have cashed out. So, I didn’t include any public companies just to keep the analysis simple.

  2. Adam said, on November 11, 2009 at 1:14 pm

    You are correct sir.

    Here are two posts from Josh Kopelman at First Round highlighting the same issue.

    http://redeye.firstround.com/

    • larrycheng said, on November 12, 2009 at 10:10 am

      Adam, I’m a big fan of where Openview is going. I think your firm is situated beautifully based on some of the systemic structure issues in VC (like the law of large numbers).

  3. Jim Sanger said, on November 11, 2009 at 7:15 pm

    Larry
    The economics you mention makes me glad that my firm decided to keep to a modest fund size.

    BTW, Evalve had an additional earnout of up to $90m on top of the $320m mentioned in the WSJ/Venturesource list.

    Compuware’s acquisition of Gomez (over in Lexington) also closed on Monday of this week for $295m, all cash, no earnout. The Gomez acquisition didn’t get all that much coverage in the VC press, but was still one of the Boston area’s best recent venture-backed exits (along with BBN Tech, RueLaLa, Starent, and A123).

    And among those in the “announced but not closed” category I guess one has to include yesterday’s announced acquisition of LifeSize by Logitech for $405m.

    Does seem like the exit window for venture-backed companies is creeping open again.

    On the other hand, it is interesting to note just how many of these top deals were done by the same *very* small cluster of acquisitive buyers. Medtronic did 3 (Ablation Frontiers, Corevalve, Ventor), Abbott 2 (Evalve and Visiogen), Intuit 2 (Mint and PayCycle), Cisco 2 (Pure and Starent), etc.

    -Jim

    • larrycheng said, on November 12, 2009 at 10:09 am

      Jim – thanks for the comment. How could I forget about Gomez? I guess I started with an incomplete list and ended with an incomplete list. It wouldn’t change the end result materially, but that’s beside the point. Thanks for pointing it out.

      Also interesting point on the acquirers. Intuit, Cisco, now Google are all active. We hear all the big buyers are in serious shopping mode right now.

  4. Ken Wallace said, on November 11, 2009 at 10:19 pm

    Exactly! Venture isn’t broken per se, but venture investing out of a large fund is. Good stuff.

    • larrycheng said, on November 12, 2009 at 10:12 am

      Ken – that is the point. I’m actually a big fan of VC and if returns were published, we’d see a number of smaller funds doing really well. The double whammy on the large funds is they got to be large because they were successful. And because they are successful, they charge more. So, not only are they fighting the law of large numbers, but also fighting netting out larger fees. Some will succeed even with a large fund, but it’s incredibly hard.

  5. […] article on the funding start-ups have received in the last year – Larry Cheng has a blog post explaining the financials. The fictional small VC firm made a better cash on cash return for its LPs through one winner, than […]

  6. James said, on January 21, 2010 at 1:59 pm

    btw…those returns are PATHETIC esp over 10 years.

  7. […] I mean traditional early stage venture capital.  Firstly, the large venture funds run into the law of large numbers – no matter how good you are, turning a good multiple on a large fund is hard especially when […]


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