Professor Raiton’s Inside Perspectives: Entrepreneurship, Creativity, Innovation

From Get Venture by Mark Davis

In my post, The Market For Venture Capital, I stated that the VC valuation market is a two sided market.  The first side of that market is the market for Investable Capital, referring to the market for capital that VCs need to raise in order to invest it in startups.  Venture Capitalists typically get their funding from institutions, such as pension funds and universities.  Like VCs these institutions create portfolios of investments, of which venture capital is often only one asset class.

These portfolios are typically divided into pools of capital that are allocated to traditional assets (e.g., public stocks and bonds) and alternative assets (e.g, hedge funds, leveraged buyout and venture capital).  While some institutions earmark portions of their portfolio for venture capital, many only decide what portion will be allocated to alternative assets, leaving the various types of alternative asset managers (e.g., hedge funds, leveraged buyout and venture capital) to duke it out for a share of the pie.

While institutions evaluate alternative asset managers based upon a number of criteria, returns not surprisingly play a key role in determining whether or not a manager gets the investment.  As a result, when VCs make their investments in their portfolio companies they are investing with an eye toward realizing the type of overall portfolio return that they need in order to generate competitive return that will enable them to raise their next funds.

In sum, the performance of other alternative asset classes and the return expectations of institutions in no small part drive VC return objectives.