March 11 2011
by Todd Hixon

The Shape of VC Today

From its post-WW II beginnings to the mid ‘90s, small-to-medium size venture funds ($100m-$400m in today’s dollars) dominated U.S. venture capital. They launched much of the tech industry. Angel money was limited, and later stage funds were few. So VC was a bit like a prosperous gentleman: thicker in the middle, thinner at the top.

Rich VC returns of the late 90s caused investors to pour in capital, producing the billion-dollar venture fund experiment, which was mostly a bust. Funds scaled down in the early 200X years, tried to get bigger, then were beat down by the 2008 financial crisis, or so I thought.

Recently “Super-Angels” blossomed, fed by the Web 2.0 boom: companies can be started cheaply, and the most successful ones can grow value extraordinarily fast. Some of the successful super-angels raised institutional money. The industry was filling out at the bottom.

Surprisingly, in the last year the billion dollar venture fund has returned (more). Greylock just enlarged its fund to $1 billion, following Accel and Kleiner, with much of this money earmarked for later-stage investment. Kleiner now holds stakes in all four of the hottest Web 2.0 companies, but three of those stakes were acquired at later stage.

Participation by selected established/big and small/new funds in hot web 2.0 deals. (From VentureSource)

VC now looks more like the stereotypical Victorian lady: filled out at the bottom, and well endowed at the top, too.

It’s hard to prove what works in VC. The market has big cycles; data is private; and success takes 10 years to emerge. But, recently, Lerner, Leamon, and Hardymon did a convincing analysis of the relationship of IRR and fund size, summarized below  (1).

The optimal fund size is about $200 million, and further increase depresses returns. However, the best GPs tend to increase their fund sizes, and they persist in outperforming the average. Persistence effect offsets the fund size penalty up to about $500 million, flattening the peak (2).

A new group called Correlation Ventures have extended this work with fascinating results, and built their strategy on it. Take a meeting with them to learn more.

So, what’s happening with the shape of U.S. VC?

  • The capital-efficient Web 2.0 innovation wave spawned new funds at the bottom of the size range, the best of which have scaled up to the mid-range.
  • Some of the best-known managers have a strategy of investing large amounts at high value in the few deals that break away. This is essentially a substitute for the diminished IPO market.
  • The best evidence agrees with my experience: a small, hands-on team investing a moderate-size fund produces the best return.


  1. From: Lerner, J., A. Leamon, and F. Hardymon, 2011, Private Equity, Venture Capital, and the Financing of Entrepreneurship: The Power of Active Investing, New York, Wiley.
  2. For more, see: “It Ain’t Broke:  The Past, Present, and Future of Venture Capital”, Stephen Kaplan and Josh Lerner,  2009

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