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Repeat Performance?

When I wrote recently about Backing into 20%, or why big VC funds face challenges in getting big returns while they want to own as much of a company as possible, I missed one obvious point.

When I compared the kind of returns that a smaller fund, like Fred Wilson's Union Square Ventures, needs to have versus those that a bigger fund needs, I skipped over another solution.  Why can't the bigger fund just do what the smaller fund does many times over?  A $750M fund can just do what a $125M fund does six times.  That means that the bigger fund needs to have six times the partners finding six times the number of great opportunitites.  Each of those opportunites can have the profile of the returns that I described for the smaller fund.

Mathematically, that all works.  But, the math doesn't map to reality.  The scarce resource is the entrepreneur who can build a company that delivers the great returns.  It's a competitve market out there for these entrepreneurs, and if your firm has to find 6x as many of them as a smaller firm does in order to have a similar return, your firm is bound to lower the quality bar in the name of putting the money to work.  And, you need to put the money to work in order to justify taking a management fee on the big fund.  And, that's the dirty little secret of today's large venture funds.  It's almost impossible for a big fund to repeat the success that smaller funds can have with early stage deals.

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