Private Equity, Patience & Deal Fatigues

Fred Wilson earlier wrote venture capital is patient capital.Highlighting that even the most patient investors can get tired of supporting an investment, often called "deal fatigue", he points out the typical life cycle of a venture deal is five to seven years. The returns in ventures can be negative in the early years, get positive in year 3 or 4, and then grow from there, typically called the J curve – this can also show the typical annual cash flows of a startup company. They are negative for two to four years, turn positive, and grow from there, thereby creating value for the entrepreneurs, operators, and investors. Other way to put it - The IRR curve over time for an early stage VC fund – that period of time in advance of mass-confirmation of a new idea. Nick points to the classic J-Curve available from the CalPERS site.
CalPERS report points out, in practice, a private equity portfolio involves a series of J-Curves because funds are invested in at different times. However, not all funds will be profitable given the inherent risks of investing in private equity, including macroeconomic factors and the performance of underlying companies.
Deal fatigue is driven more by money than time and it can be a very destructive emotion in the board room if it is not managed properly. As Fred sees it, there are ways to avoid them:
- First, don’t let the J curve flatline. Get profitable in a reasonable period of time. Two to three years is typical, five years is too long.
- Second, bring new investors into the syndicate every time you raise money. The investors who wrote the checks in the A round might be tired by the E round, but the D round investors will have fresh legs.
- Third, start with a low valuation and slowly and carefully build it in each investment. The investors will be less tired if they see the value of their investment increasing in each round. He cautions that there is nothing worse than a tired investor with a paper loss on his or her hands.
With increasing expectations of private equity,this makes an wonderful read - amazing dosage of wisdom.