For the last few years, the spotlight in start-up investing has largely shone on those who poured money into a company when it was already well along on a growth path. It turns out that spotlight may have been misdirected.
While some investors are throwing giant sums into more mature start-ups like Uber and Airbnb at soaring valuations, it is the venture capitalists who identify a promising company at its infancy and bet on its growth who often come out on top.
Known as early-stage investors, they dominate a list of the top 20 venture capitalists worldwide that was recently created by the research firm CB Insights. About three-quarters of the top 20 are investors who put money into start-ups during their early rounds of financing. Only a handful on the list are focused on investing at a later stage in a company’s life.
CB Insights generated the list using criteria such as how big a return an investor was able to produce when his or her investments went public or were acquired. CB Insights focused on the performance of investors since 2008 for the list.
The top 20 includes Peter Fenton of Benchmark, who invested in Twitter when the social media company had only 25 employees and was trying to fix its once-common service failures; the company went public in 2013. The list also includes Jim Goetz at Sequoia Capital, who was one of the few to invest in the messaging service WhatsApp before it was acquired by Facebook, and Jenny Lee of GGV Capital, who was among the earliest investors in 21Vianet, a Chinese data center services provider that has since gone public.
The idea that early-stage investors can generate much larger returns has long been a core principle of venture capital: Get in early and grab a bigger stake in a company, with more opportunity for a larger return later, the thinking goes.
Early-stage investments have accounted for the lion’s share of the venture industry’s gains since 1994, according to Cambridge Associates, a research firm that studied the quarterly financial reports of dozens of venture firms. Since the dot-com boom of the late 1990s, between two-thirds and three-quarters of the industry’s returns have been generated by early-stage investments in any given year.
But the value of investing in a company when it is still nascent has been somewhat obscured in recent years as hordes of non-traditional start-up investors—including mutual funds, hedge funds and sovereign wealth funds—have piled into private tech companies, often when those start-ups are already proven growth stories. When Uber raised around $2.1 billion in December, for example, one of its investors was Tiger Global Management, a New York investment firm with a hedge fund component.
Rebecca Lynn, a managing director and co-founder of Canvas Ventures who is on the CB Insights list, said early-stage investments generally pay off more because “investors can get more of an ownership stake and you’re also part of the team”.
Lynn, who invested early in the alternative lending platform Lending Club, which went public in 2014, added that “later-stage investing is more like a stock bet. You’re along for the ride”.
Yet there is more risk in early investing, since unproven start-ups can easily fail.
“There are so many unknowns, from what the core business is going to look like to what the team is going to look like,” said Danny Rimer, of Index Ventures. He is also on the top 20 list, partly because of an early bet on King Digital Entertainment, the maker of the game Candy Crush that went public before being acquired by Activision Blizzard. (Rimer also invests in firms in their later stages.)
Early-stage investing has changed in recent years. The top-returning venture-capital investments in any given year were once dominated by just a handful of brand-name, early-stage venture firms. That has shifted: During the last decade, new venture firms have contributed to an increasing share of the best investments, according to Cambridge Associates.
New players have been successful partly because they have been more willing to put money into companies outside Silicon Valley, especially in China, where start-up success stories have been abundant over the last decade, Cambridge Associates said in a report last fall.
That has benefited venture capitalists including Lee and Neil Shen of Sequoia Capital, who made names for themselves by investing early in Chinese start-ups that went public: Lee in the social network YY.com and Shen in the Internet security company Qihoo 360. Shen is also on CB Insights’ list of top 20 investors.
“The tech market has massively expanded, and tech is now far more accessible all around the world,” said Theresa Hajer, a managing director at Cambridge Associates.
As more venture firms have snagged pieces of the top deals, more have also taken pieces of the return pool, lowering the overall gains for the venture industry as a whole. Before the dot-com bust of the early 2000s, huge returns of 25 times the original investment amount were the norm for the top investments.
Since that period, it has been much rarer for the top investments in any given year to yield a 25-fold return, according to Cambridge Associates data.
For the foundations, endowments and pension funds that have poured billions into venture capital funds, finding the right early-stage investor remains a challenge. Scott C. Malpass, the chief investment officer at the University of Notre Dame, said he could count on two hands the number of venture investors who could successfully identify which young start-ups would make the transition to lasting companies.
“I just want to be in the top two to three companies, not the top 100, because that’s where the next Google or LinkedIn will be,” Malpass said about his philosophy of working with early-stage venture capitalists. “It’s still a home run game.”