VC Returns Data - Lacking Alpha | The SaaS Business Model's Promise | Relationships
Perspectives and Quick Takes From Bigfoot and Our Community of B2B Software Operators and Investors
Happy Wednesday,
Welcome back to another edition of the Bigfoot Bi-Weekly Roundup.
This week I’m sharing my and others’ thoughts on:
VC TVPI data
The Promise (or mythology for some) of the SaaS Business Model
The Importance of Relationships and Scaling Them (with link to blog post)
VC TVPI (Cash on Cash Returns) Since 2013
I ran across this informative LinkedIn post providing insight into declining VC return performance over the past decade along with some pretty pointed viewpoints on the underlying problems that have arisen in venture, driven by both LPs and GPs.
“In recent times, the incentives guiding institutional investors, VCs and the founders that receive investment are categorically misaligned…Deploying large chunks of capital isn't really beneficial for anyone. Startups are suffocated and VC funds have lower returns which flow through to the institutional investor.”
The writer posits, and I largely agree, that the vast amount of capital flow from institutional LPs to venture capital GPs over the past decade has resulted in over-saturation that has compromised underlying company performance. The ballooning size of VC funds has led to the overcapitalization of companies. The resulting “Growth at all costs” execution playbook to become a Unicorn simply has not delivered cash distributions to generate alpha (excess return generated per unit of risk taken) going back as we can see below when looking at TVPIs over the past decade.
TVPI: The ratio of the current value of remaining investments within a fund, plus the total value of all distributions to date, relative to the total amount of capital paid into the fund to date. (source: International Limited Partners Association)
A couple of thoughts on each component that delivers TVPI:
Total value of all distributions to date - As we’re well aware, distributions are hard to come by in this market. Maybe that gets unlocked with a re-opened IPO window and more meaningful M&A activity in 2024, but if it stays the way it’s been the past 18 months, expect continued TVPI underperformance.
Current value of remaining investments within a fund - Written down marks within venture portfolios are occurring and will likely continue with pressured company performance and downrounds causing further TVPI degradation.
We can assume the 2013-2016 vintages that achieved >2x median TVPI were from investments made in the 2003-2008 timeframe (post 2000-cash / pre-GFC-cash). Since that time, we’ve seen <2x median TVPI, driven by increased LP allocations to VC resulting in larger fund sizes paired with a dearth of distributions as companies have chosen to stay private longer (or really their investors have chosen for them, plowing more capital into them).
As we’ve all been hearing, great companies (and investments?) are created in the hardest of times. So maybe the 2023-2025 vintages will get TVPIs back up (come on AI!) and maybe the IPO window truly will open back up in 2024 and we’ll see massive distributions back to LPs, thereby improving the TPVIs in the table above. Or…maybe not.
TVPIs could also be driven up by a reversion of LP allocation to VC resulting in more reasonable fund sizes that can actually deliver an appropriate return on capital deployed, which I’d argue for the VC asset class is >3x (of course, I’m not an LP).
I saw another LinkedIn post detailing some highlights of a study conducted by Raise Global (a community for emerging fund managers and LPs) of 656 VC funds. To the point of larger funds having a harder time generating alpha (strong TVPI), the survey found that:
Most 10x (unicorn) funds are small: "Out of the 12 unicorn funds, only two funds exceeded $20M. The majority raised less $10M".
Now, I doubt that much institutional LP capital was in those funds given their size. So, the real return benefits likely went to retail HNW LPs (great for them!), which of course does nothing to help institutional LPs allocated to VC or the individuals whose money those LPs are managing in the first place.
🔊 Bigfoot Quick Takes 🔊
SaaS has great potential but doesn’t always deliver on it
Well, here’s what I think:
The SaaS business model is neither a myth nor is it bullsh&t. I believe the thesis behind it is a sound one. However, I also believe that just because there is a sound thesis that does not mean the business model itself inherently gives anyone a free pass or a premium valuation, that has to be earned and justified.
The core business and investment thesis behind the subscription software business model (SaaS) is that the company and investors get an annuity that's worth investing in upfront to acquire the customers that deliver that annuity. It truly can be a wonderful thing with massive value.
It doesn't just happen though...
Customer acquisition must be repeatable, efficient, and ultimately profitable (and hopefully more so over time). In order for this to be the case, SaaS companies must at least retain and, even better, expand the revenue generated from those acquired customers and must be able to acquire customers in a cost-effective manner over the long-term, no flash-in-the-pan cohorts!
If neither of these is happening, the company is not actually creating an annuity that justifies the growth spend (and capital raised to fund it).
Also, it’s not enough to just have a revenue annuity. It actually needs to become a cash-flow annuity.
Relationships as a Product
I came across this post from a friend the other day and could not agree more.
It reminded me of a blog post I wrote a couple of years back on the concept of “Relationships as a Product”. (Here it is)
The TLDR is: I think if you view and treat relationship-building and nurturing as a core feature of your product/service and not as something that “doesn’t scale”, you set both yourself and those you work with/for up for success.
In business there are the company and its results and there are also the people behind it working to deliver those results. Relationships are how we see beyond the headline results with greater context and empathy and truly deliver support.
About Bigfoot Capital
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One of the best posts of the year. Our enterprise customers love our software but more so, they trust us and that has come from building personal relationships with them and always putting them first.