A New Way to Measure VC Success

Guest Post By Fernando Fabre: Insights from the Kauffman Fund Returners Index

One of the driving convictions of my work is that innovation is and will continue to become democratized. Since 2013, when I started in venture, the number of cities that have created a unicorn has exploded from 4 to over 150 today. This has had real impact on local startup communities, and entrepreneurial dynamism - much of which I have explored in Out-Innovate. One of the corrolary effects is on the venture ecosystem. A few weeks ago, my friend Allen Taylor who leads Endeavor’s venture program wrote about the internationalization of the Midas List. Where Endeavor has an unparalleled lens on local startups around the world, Kauffman Fellows, the global VC organization, has on the venture ecosystem. They just created a new global ranking of venture capitalists - The Fund Returner Index (where Fluent Ventures, the firm I cofounded was ranked #22). In today’s guest post, I’m excited to host Fernando Fabre, Kauffman Fellows’ CEO, for a guest post to explain why they created the Index and what the inaugural results mean for VC.

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Guest post: Fernando Fabre, CEO of Kauffman Fellows

Kauffman Fellows released an exciting VC report—the first Fund Returners Index. As a community of nearly 1,000 venture capital investors from over 60 countries representing over 680 VC firms, we constantly discuss what success looks like in our industry. While measuring the success of these VCs should be straightforward, there is no universally accepted measure to determine which are the most successful VC firms. In our latest report, we suggest a new method for doing exactly that.

One of our core beliefs at Kauffman Fellows is that venture capital supports entrepreneurs in building category-defining startups. These early-stage companies not only generate favorable results for their VCs and other stakeholders but also create massive, well-documented positive externalities, such as the famous “PayPal Mafia.”

A category-defining startup can also transform the reputation and success of a venture capital investor if it achieves an exit that brings about exponential returns. We call these startups “firm-defining.” Don Valentine (Sequoia) investing in Apple, John Doer (Kleiner Perkins) investing in Google, and Santi Subotovsky (Emergence Capital) investing in Zoom are some examples.

The Kauffman Fellowship defines success as VCs that consistently source, invest, and exit category and firm-defining startups. We use three equally weighted metrics as proxies for success: the number of investments made that became a unicorn after the investment, the number of newly minted unicorns that had an exit at $1b+, and the total sum of the exit valuation of those investments.

Our Measurement Model

Using the three equally weighted metrics, we assume that a startup that reaches unicorn status is likely succeeding and defining a category (within the industry). Still, without a significant exit, it does nothing for VC success. Thus, startups that exit at unicorn+ valuations are likely to define the VC firm's success and, thus, its reputation.

What these equally-weighted metrics imply is the following: A VC firm that invested in only one startup that became a unicorn, which had an exit, and the exit valuation being $1b (in other words, 3 points in total—one unicorn, one unicorn exit, and one billion in exit value), has the same rank as a VC firm that has invested in three startups that became a unicorn with no exits yet (3 unicorns = 3 points). The same logic applies to a firm that invested in only one unicorn and had an exit at a $10b valuation (one unicorn, one exit, and ten billion = 12 points) versus a firm that invested in 12 unicorns = 12 points. A VC firm with 12 unicorns in its portfolio should expect solid distributions to LPs, comparable to a firm with one big exit.

Where the Data Comes From

The report's data comes from three sources: First, we pulled Pitchbook and Crunchbase information for all 940 Kauffman Fellows in our community. We also complemented this data through a survey wherein each Fellow could update their investments with attribution. In total, we counted over 1,800 unicorns minted in the last ten years, of which 311 have had an exit at a valuation equal to or higher than $1b. Further, we uncovered that one in four unicorns minted over that timeframe are from California, one from China, one from the rest of the US, and one from the rest of the world.

Why We Published This Report

We decided to publish this for many reasons. The first is to showcase that our community's VCs disproportionately impact the VC industry. One in five unicorns minted worldwide has a Kauffman Fellow in the cap table and the same holds for exits over $1b. Kauffman Fellows have had nearly a third of a trillion dollars worth of exits in that time frame.

A second reason is to understand better the profile and diversity of successful venture capital models. The Forbes Midas List, for example, is by far the most recognized ranking of venture capital success, yet it has a limited scope. It's limited to including specific VC models, such as high ownership positions, early-stage positions, leading rounds, and managing third-party money from multiple LPs. It is also biased towards US investments due to the nature of their submissions and access to data.

This approach leaves out alternative VC models designed to take a different position on the risk/reward curve. For example, VC firms that take smaller equity stakes with more extensive portfolios, later-stage secondary firms, single-LP firms, solo GPs, and even LPs making occasional direct investments. We see the value of these alternative VC models to the industry, which wouldn’t work correctly without the different players. Further, Kauffman Fellows has a unique position to measure different geographies, given the nature of our community, which spans six continents and over 60 countries.

One of the pushbacks we received was that an early-stage high-conviction investor should receive more recognition for being the first big check in a startup compared to a VC that invested at a later stage or with a smaller check. We see no merit in this presumption because we understand that in VC, as in any industry, the risk/reward curve can be optimized by model selection. A VC secondary firm certainly takes less risk than a high-conviction seed VC firm, but both have equal merit in their approach and value to the whole ecosystem.

Key Findings & Takeaways

1. Kauffman Fellows are Making Waves: Our community represents 20% of the success in the global VC industry (1 in 5 unicorns and exits have a Fellow in the cap table). If you are an LP figuring out manager selection, investing in a Kauffman Fellow gives you a solid 20% expectation of success (in an industry driven by power laws, predicting a 20% success rate in a power law dynamic is as good as it gets).

2. Success is Everywhere. While most of the success recorded in this report comes from the US (two-thirds of all unicorns and exits), this is partly explained by the nature of our network, which was US-centric for over two decades. Our scope has become global, especially over the last ten years. The report highlights that four of the top ten performers within our community have invested primarily in the US. The rest invest in the rest of the world, including Europe, Asia, and Latam. Entrepreneurs are building category and firm-defining startups while changing the world from everywhere.

3. Diverse Models Work: VC success comes from different venture capital models. While traditional VC firms invest with high conviction and ownership in specific industries and geographies, our data shows that alternative VC models generate successful returns across the risk-reward return curve. These include VC firms taking early and usually small positions with a more extensive portfolio, funds investing exclusively in secondaries, and investors such as family offices and corporate VCs.

The top fifty performers include firms that invest in large portfolios (300+ PortCos) with small ownership stakes, firms that invest only in secondaries, firms with a high-conviction approach as well as funds with a higher volume approach, and even firms tied to corporates and single family offices making direct investments. This implies that the venture capital industry benefits from innovative models along the risk/reward curve, which benefits the growth curve of those entrepreneurs and their startups.

What’s Next?

The globalization of VC isn’t slowing down. While 65% of all unicorns minted with a Kauffman Fellow in the cap table are from the US, nearly two-thirds of our report's top ten venture capitalists invest outside the US, consistent with the trend on the Forbes Midas List. The globalization of venture capital will continue on this path.

Further, alternative venture capital models that innovate in their approach to sourcing, investing in, and exiting startups will continue to sprout. Regions outside the US will continue to see the launch of traditional VC firms leading with high conviction and alternative models investing with a different portfolio construction approach. We will also see the nascent growth of secondary vehicles to provide early liquidity to the market. This evolving landscape is great news for entrepreneurs and investors everywhere.