1. The Future of Venture Investments Cycles,
Trends and Opportunities
Journey Conference
October 25, 2012 Israel
Felda Hardymon
Copyright © President & Fellows of Harvard College

2. VC is really an adolescent asset class
Venture capital is still very young:
• Not recognized as a real asset class until 1978
Venture capital is still very small:
• In largest market, U.S.:
• Only about 4000 professionals.
• Average of 1,500 companies funded for first time annually, 2000- 2008.
• Relative to 1 million businesses started annually.
• In Israel:
• Less than 250 professionals
• Less than 25 Series A’s each year—many more seed deals

3. VC is really an adolescent asset class
Venture capital is still very young:
Whether or not you
• Not recognized as a real asset class until 1978
raise venture
Venture capital is still very small:
• In largest market, U.S.:
capital:
• Only about 4000 professionals.
if you are in high
• Average of 1,500 companies funded for first time annually, 2000- 2008.
• Relative to 1 million businesses started annually.
• In Israel:
tech—the health of
the VC industry
• Less than 250 professionals
affects you
• Less than 25 Series A’s each year—many more seed deals

4. Venture capital has had a profound impact in the US
economy
• 13% of all public firms at end of 2008.
• 8% of market capitalization ($2.0 trillion).
• 6% of total employees.
• Particularly true in high-technology industries.
And over the past decade has become important globally
• Israel ahead of the curve on this—active VC since mid-80’s; a real
industry in the early 90’s
• VC responsible for bringing dozens of multi-nationals to Israel through
M&A

5. Venture capital has had a profound impact in the US
economy
• 13% of all public firms at end of 2008.
• 8% of market capitalization ($2.0 trillion).
• 6% of total employees.
• Particularly true in high-technology industries.
And over the past decade has become important globally
• Israel ahead of the curve on this—active VC since mid-80’s; a real
industry in the early 90’s
• VC responsible for bringing dozens of multi-nationals to Israel through
M&A
VC is the oxygen for high tech
innovation

6. Today
The Theory
The Reality
Current State
Starting a Company Now
What Works

7. Venture Capital
The Theory

9. Georges Doriot’s insight
Worries about dangers of post-War stagnation in
U.S.
Current system did not work well:
• Limitations of banks, public markets.
Need for new financial institution playing three
roles:
• Sorting.
• Certifying.
• Governing.

10. What VCs Do
Selection
• Pick which projects to back
• Driven by profit share self interest (carried interest)
Credential
• Indicate to acquirers, banks, large customers, potential employees, etc that
this is a substantive project
Governance
• Regularly monitor progress at a meaningful level and effect changes if
necessary

11. What VCs Do
Selection
What VCs don’t do
• Pick which projects to back
• Driven by profit share self interest (carried interest)
Credential
Run Companies
• Indicate to acquirers, banks, large customers, potential employees, etc that
this is a substantive project
Governance
• Regularly monitor progress at a meaningful level and effect changes if
necessary

12. Because of its structure,
VC is a long latency business
Blind pool
• May be a broad investment charter (healthcare vs. IT, start-up vs. growth
equity, etc).
Long lock-up
• 10-15 years
Long investment life
• Time to liquidity 5-10 years
Apprenticeship
• 15-20 years to know if a VC investor is any good

13. The Venture Capital
Intermediary Chain
Fund
Managers Gatekeepers
Savers Venture Portfolio IPO
(e.g., Pension (e.g., Fund
Firms Companies
Funds) of Funds)
3 – 10 Years 3 – 10 Years
13

14. The Venture Capital
Historically American and
Intermediary Chain
European; recently SWFs and
Asia have become important. It
is a longer chain for Israeli VCs.
Fund
Managers Gatekeepers
Savers Venture Portfolio IPO
(e.g., Pension (e.g., Fund
Firms Companies
Funds) of Funds)
3 – 10 Years 3 – 10 Years
14

15. VC Interim Performance is
Hard to Measure
Mark to market cannot be accurate
• Comparison based: But what are comps for new businesses?
• Interim financings often more affected by exogenous variables (fund cycle,
buzz, speculation, etc) than by company performance
• Company progress often driven by a series of experiments and is inconsistent
over time until established.
VC fund performance quite dependent on liquidity environment—which
varies greatly over time.

16. Venture Capital
The Reality

17. Big Hits Drive VC Actual Performance
It is a risky business
• Over half of VC investments do not return what’s invested
About 15% of VC investments drive all VC returns
Great companies are started every year, BUT there are only a few and
access is key
• Drives tiering of the business
• Exacerbates VC cycles
Makes allocation of time more important than allocation of capital.

18. VC is Cyclical
Greatly affected by IPO/M&A cycle
• First real measurement of VC fund performance
• Liquidity itself is a big indicator for raising a new fund
Underlying start-up cycle
• Macro economics (recessions help!)
• Innovation cycles
• Role models
Returns negatively effected by overfunding
NOTE: Debt cycle is not a performance factor (does affect LP
fundraising somewhat)

19. The VC industry underperforms when overfunded
Very Good Returns
100
82
Good 77
LP Returns (%)
80 75
Returns
Strong 52 56
60 Firming Returns
Returns Bad Returns
40 33 34 34
28 Bad Returns
20 18 18 20 19
20 13 15 14
9 10 9
0
-20
-18
-23
-40 -32
1,000,000
70s 80s 90s 00s
100,000
to US VC Funds ($M)
Dollars Committed
10,000
1,000
100
PC Boom Internet Boom
10
1
Source: Cambridge Associates

20. U.S. fundraising and pooled IRR
30.00 180
160
25.00
140
20.00 120
Funds (2002 $B)
100
IRR (%)
15.00
80 Pooled IRR
Funds Raised
10.00 60
40
5.00
20
0.00 0
1969-1975
1976-1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Source: HBS databases and Thomson Reuters.

21. U.S. fundraising and pooled IRR
30.00 180
160
25.00
140
20.00 120
Funds (2002 $B)
100
IRR (%)
15.00
80 Pooled IRR
Funds Raised
10.00 60
40
5.00
20
0.00 0
1969-1975
1976-1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Source: HBS databases and Thomson Reuters.

22. VC is Not Process Driven
Judgment and effectiveness of the VC partners counts most
• Great firms are somewhat consistent across partners; merely good or second
rate firms are not at all consistent across partners
• VC is an apprenticeship business

23. VC is Not Process Driven
Judgment and effectiveness of the VC partners counts most
• Great firms are somewhat consistent across partners; merely good or second
rate firms are not at all consistent across partners
• VC is an apprenticeship business
Advice to VCs
Go to the best firm you
can to learn the
business

24. VC is Not Process Driven
Judgment and effectiveness of the VC partners counts most
• Great firms are somewhat consistent across partners; merely good or second
rate firms are not at all consistent across partners
• VC is an apprenticeship business
Advice to VCs
Advice to Founders
Go to the best firm you
Choose firm 1st,
can to learn the
partner 2nd
business

25. VC may be the most concentrated financial
industry on earth—because of Persistence
Returns of all US VC
funds from inception to
2010 For top 1%: 41%.
For top 5%: 70%.
For top 10%: 84%.
For top 25%: 104%.
Returns from inception to 12/31/09.
Source: Lerner analysis of Thomson/Reuters data.

26. VC may be the most concentrated financial
industry on earth—because of Persistence
BUT the returns of the industry as a whole do not
justify the total LP money invested in VC funds
Returns of all US VC
funds from inception to
2010 For top 1%: 41%.
For top 5%: 70%.
For top 10%: 84%.
For top 25%: 104%.
Returns from inception to 12/31/09.
Source: Lerner analysis of Thomson/Reuters data.

27. A VC firm’s track record indicates more than in any
other asset class
Next Fund Bottom Medium Top
High likelihood that the next
Last Fund ↓ funds of a given partnership
stays in the same
performance bracket
Bottom Tercile 61% 22% 17%
 Persistence.
Medium Tercile 25% 45% 30%
1% boost in past
Top Tercile 27% 24% 48% performance → 0.77% boost
in next fund’s performance.
Source: Kaplan and Schoar [2005]

28. Fund sequence number
14%
• Positive relationship
12%
between IRR and fund
sequence number.
10%
• First time funds perform
Predicted Relative IRR
8% especially poorly.
• Regression results control
6% for vintage year effect, fund
category and fund size.
4% • May need to be done
separately for Israel—early
2% wave of funds (early 90’s)
was blessed by a rising
0% market. Time will tell.
1 2 3 4 5 6 7 8 9 10
Fund Sequence Number
Source: Lerner, Leamon and Hardymon [2011]

29. But VC has scaling limits
25%
20%
Predicted Relative IRR
15%
Buyout
Venture Capital
10%
5%
0%
10 20 50 100 200 500 1,000 2,000 5,000
Fund Size ($ millions)
Source: Lerner, Leamon and Hardymon [2011]

30. One Explanation: Partner to size ratio
(i.e.: “Judgment … not process driven business”)
2.5%
2.0%
1.5%
• Positive relationship
between IRR and the ratio
1.0%
of partners to committed
0.5% capital.
Relative IRR
0.0% • Regression results control
-0.5%
for vintage year effect,
fund category, and fund
-1.0%
size.
-1.5%
-2.0%
-2.5% Source: Lerner, Leamon and Hardymon [2011]
-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50%
Ratio of Senior Professionals to Fund Size, Relative to Mean Fund

31. One Explanation: Partner to size ratio
(i.e.: “Judgment … not process driven business”)
2.5%
2.0%
1.5%
• Positive relationship
between IRR and the ratio
1.0%
of partners to committed
0.5% capital.
Relative IRR
0.0% • Regression results control
-0.5%
for vintage year effect,
fund category, and fund
-1.0%
size.
-1.5%
Remember what VCs do:
-2.0%
Selection, Credentialing, Governance
-2.5% Source: Lerner, Leamon and Hardymon [2011]
-50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50%
Ratio of Senior Professionals to Fund Size, Relative to Mean Fund

32. Explanation 2: Older Firms Tend to be Less
Specialized
Source: Gompers, Kovner, and Lerner [2010]

33. And Specialist Firms are More Likely to Have
Successful Deals.
Partners’ focus
especially matters.
3%
Specialization assists
2%
• Selection
• Credentialing
1% • Governance
0%
Specialized Generalist Generalist
Firm with Firm with Firm with
Specialized Specialized Generalist
People People People Source: Gompers, Kovner, and Lerner [2010]

34. VC is relatively uncorrelated
to the larger business cycle
VC economics are micro not macro
• Moving from 1515100 customers just requires finding those customers
• Truly great companies are founded in all periods … regardless of economic
cycle
VC results require healthy public markets for exit but not for growth
• So VC industry performance is lagged to the public markets (makes VC an
uncorrelated asset from a portfolio construction point of view)

35. VC industry performance is
lagged to the public markets
Inter-quartile ranges and medians for asset classes (c. 2006)
20%
15%
10%
5%
0%
-5%
-10%
U.S. Fixed U.S. Large U.S. Small Non-U.S. Hedge Real U.S. U.S. European
Income Cap Cap Equity Funds Estate Venture Buyouts Private
Equity Equity Capital Equity
Source: Yale [2006] and Venture Economics.

36. Lag to the public markets makes VC (& PE) an uncorrelated
asset
Modified Correlation Matrix
U.S. U.S. Developed Emerging Absolute Private Real
Equity Bonds Equity Equity Return Equity Estate Cash
U.S. equity 1.00
U.S. bonds .45 1.00
Developed
.60 .30 1.00
equity
Emerging
.30 .20 .50 1.00
equity
Absolute
.30 .35 .30 .30 1.00
return
Private
.40 .25 .25 .10 .25 1.00
equity
Real estate .15 .25 .20 .10 .40 .15 1.00
Cash .00 .50 .00 .00 .00 .00 .20 1.00
Source: Yale University Investments Office c. 2003 (Modified correlation matrix reflects assumptions about future interrelationships)
36

37. Great Companies are Created Every Year 1980-1996
1980 1982 1984 1986 1988 1990 1992 1994 1996
37
Source: BVP research

38. Great Companies are Created Every Year 1997 - 2010
Truly great
companies
are founded
in all periods
… regardless
1997 1999 2001 2003 2005 2007 2009 2011economic
of 2013
cycle
38
Source: BVP research

39. So VC is subject to long latency, multiple cycles,
huge concentration, and inaccurate
measurement
There are few VC industry experts for all situations
• Advice is often anecdotal
• Venture capital admits a lot of styles
Investment platform, track record and acumen trumps a good story,
empathy or simply domain knowledge
But most of all, it is really about Governance

40. Venture Capital
Current State

41. The Mid Sized VC is no longer viable
Sector Middle
market Major
and geo
funds global
specific
funds funds

42. The Mid Sized VC is no longer viable
Firms have specialized and Persistence has driven
gotten smaller to ease LP funding to higher
fundraising and increase performing funds who
performance have expanded to take it
Sector
and geo Major
specific global
funds funds
And the two classes of firms are
symbiotic

43. And which funds can easily raise money has narrowed
considerably
Top 15-20 funds (most global)
• Expanded into growth equity
Top 1/4 • Specialization
Sector &
LPs getting
Geo
Funds ‘specialist fund
fatigue’
Sector & Geo Funds
Ten Years Ago Now

44. And which funds can easily raise money has narrowed
considerably
Top 15-20 funds (most global)
• Expanded into growth equity
Top 1/4 • Specialization
Differentiation key Sector &
LPs getting
Geo
Funds ‘specialist fund
fatigue’
Sector & Geo Funds
Ten Years Ago Rise of the Now
Super Angels

45. Scrappy
The case for Israeli VC
Unconventional
Nonconformist
Impatient Nimble
Aggressive
Ambitious
Proud Informal
Clever
Audacious
Improvise Optimistic
Pioneering
Brash Passionate
Outsider
Opinionated Assertive
Tenacious
Defiant
Unreserved
Independent
45

46. 2011 Venture Snapshot
$2B invested
500 start-ups 7.6M
75% foreign funds people
$2.3B M&A exits
($1.9B in 2012)
46

47. There is a focus on innovative high tech like no where
else in the World
Tech is 17.3% of the business sector GDP
Tech exports close to $16 billion (41%)
Over 90% of the public budgets for R&D ($7 billion in 2006)
allocated to hi-tech
• Much allocated through joint ventures with VC
Source: Israeli Ministry of Finance

48. Commonly heard objections
•No $Billion IPO
•Tech is shiny, but…
•Building a business is hard
•Scaling is really hard
•Money is easy to lose
48

49. Israeli high tech is a natural for M&A
Decrease in global corporate R&D is a good match for R&D centric Israeli companies
• Disruptive products and technologies (often difficult to take to market on their own)
• Partner with US tech companies  Early courtship
• NB: Many venture backed US start-ups are founded in order to compete with the giants
All major US technology companies have a presence in Israel
• No language issues, loyal employees, highly productive, integrate into existing R&D centers
Financial match
• US tech companies have unprecedented cash outside of the US (can't repatriate)
• Israeli capital efficiency$100M acquisition for an Israeli company is a great outcome

50. Israeli high tech is a natural for M&A
Decrease in global corporate R&D is a good match for R&D centric Israeli companies
• Disruptive products and technologies (often difficult to take to market on their own)
• Partner with US tech companies  Early courtship
• NB: Many venture backed US start-ups are founded in order to compete with the giants
All major US technology companies have a presence in Israel
• No language issues, loyal employees, highly productive, integrate into existing R&D centers
Financial match
• US tech companies have unprecedented cash outside of the US (can't repatriate)
• Israeli capital efficiency$100M acquisition for an Israeli company is a great outcome

51. THE RISK OF NOT SELLING
FINANCIAL VALUE
STRATEGIC VALUE
40 years in the desert Financial metrics
Strategic base exits are
technology rare and then
premium is unusually low
unusually high
for Israeli
companies $ M&A VALUE
VALUE
Time
Israelis haven’t $ CASH BURN
raised growth
capital nor have
spent to scale

52. Venture Capital
Starting a
Company Now

53. !
Is it a good time to start a company?
People are available
Markets are moving relatively slower
The world continues to shrink (relative advantage to Israel)
Lower costs of start-ups
More role models imply easier credibility
Many opportunities
• 45 year old IT architecture
• Replacing chemistry based pharma

54. But it is harder to grow to true scale
1. Big companies are cash rich, idea poor
• Easier to buy than build  the M&A fit
2. Investors seeking pre-mature liquidity to raise new funds  VC
environment not good for Israeli-specific VCs
3. Long term public investors scarce
4. Mid level growth management scarce
Consumer facing Internet somewhat of an exception but starting to
conform to the rest of the market

55. Venture Capital
What Works

56. Governance
Hiring people smarter than you
Patience coupled with long term vision
Go with experienced investors
Be global from day 1
Develop the ability to hire and train
Avoid large banks
Measure everything

57. Elements of Good Governance
An outside board
• Neither dominated by management nor VCs
• Finding independent, unaffiliated directors is hard
• Small (5-7)
• Characterized by respect and affection of members and role players
Best practices
• Auditing, law, compensation all have process
• Budgeting, forecasting and regular monitoring
• Allows experiments—you can be wrong and fix it
Attitude—good managers welcome the standards

58. Choosing investors
Value experienced investor over domain specific investor
• You can hire domain help
• Key to governance as well as credibility
• Platform vs individual
• A great firm will back up the partner
• Chemistry is important, respect is more important
• Communicate, communicate, communicate
• Anyone can want to make money—a good investor knows how to make
money.

59. What makes a good VC Investor?
The ability to communicate
The ability to get mind share
Discipline
A sense of equity
Empathy
Reputation
Perspective
Stability
…and luck

60. Thank You