Kauffman Report Debunks the J-Curve Theory About VC Firms

Kauffman Foundation, a non-profit foundation with an asset base of $2 billion works nationwide in the US to advance an entrepreneurial society. It undertake many programs, manages multiple VC firms and performs various other tasks ever since it's establishment in the mid 1960's. Historically, the J-Curve is used to illustrate the tendency of a venture capital firm or private equity funds. There are a variety of J-Curves but all fall initially and then rise at the end, finishing higher than the starting point.

Seemingly natural, the early years of a fund might show a red in the accounts due to the investment costs, management fees and the relative immaturity but later on when the bets start paying off, the graph rises; ending much higher than where it started. But a recent Kauffman report, shows results to the contrary and debunks this well established (notion).

This J-curve encourages LPs to accept early negative returns, and to wait for the highest returns on invested capital until the final years of an expected ten-year term. Giving evidence against this, the report says:

Our analysis of public data, and of the Foundation’s own history, shows that the J-curve effect is an elusive outcome, especially in funds started after the mid-1990s. We conducted a detailed search of academic literature and professional publications and failed to discover empirical data that substantiate the existence of the J-curve today.

We evaluated all our venture fund investments on the same ten-year investment horizon. We centered all eighty-eight VC funds from vintage years 1995–2009 on a time zero axis and plotted both gross and net dollar-weighted IRRs. Our aggregate portfolio data reveals a trend of early positive returns that resembles the shape of an “n-curve,” where net IRR peaks in month sixteen (presumably driven by increases in company valuations, which the GPs themselves determine), and retreats precipitously over the remaining term of fund life.

A rather interesting finding, read the full detailed report here.