E9: David Clark | Investment Director at VenCap on What Every LP Gets Wrong About Power Laws

Episode Summary

Executive Summary: Vencap International’s David Clark argues that venture capital is governed by power laws and cycles, so LPs should optimize for managers who have repeatedly found fund-returning companies rather than chase every emerging manager. He emphasizes persistence, ownership, follow-on reserves, and disciplined, counter-cyclical allocation as the keys to durable outperformance.

Main Topics: Power laws define venture returns (Priority: 5/5): Clark says venture returns are driven by a tiny set of companies, unlike normal-distribution asset classes, and that this reality surprises many private equity investors entering VC. Venture is cyclical, so LPs must be counter-cyclical (Priority: 5/5): He argues that bull markets and corrections are features of venture, not anomalies, and that LPs should increase conviction in strong managers when capital is scarce and be more selective when markets are hot. Manager persistence matters more than emerging-manager novelty (Priority: 5/5): Clark says the strongest predictor of future outperformance is whether a GP has already backed a fund returner, and that established core managers offer more predictable results than a broad emerging-manager strategy. Fund returners, ownership, and follow-on drive outcomes (Priority: 5/5): The conversation distinguishes unicorns from true fund returners and explains why sufficient ownership and reserved follow-on capital are essential to make a top company move the fund-level needle. Due diligence can avoid losers more easily than find winners (Priority: 4/5): Clark believes LP diligence is better at identifying weak managers than predicting top-quartile ones, because early-stage venture has substantial randomness in selecting the single best company. Firm evolution, succession, and culture sustain performance (Priority: 4/5): He notes that top firms persist by reinvesting in new partners, managing succession well, and maintaining a culture of ambition; some spin-outs succeed when they are driven by genuine opportunity and strong network effects. Fees matter less than net returns for exceptional managers (Priority: 3/5): Clark says premium carry and tiered structures are acceptable if a manager has earned the pricing power through historical outperformance, though LPs should still seek alignment.

Key Arguments: Venture capital is dominated by a small number of outlier companies, so the main job of an LP is to back managers who can repeatedly access those outliers. Past evidence is the strongest predictor of future fund-returning ability; a manager who has already found a fund returner is more likely to do it again. Emerging-manager portfolios can produce top-end results, but they also produce more bottom-quartile outcomes, making them less predictable on a portfolio basis. Ownership matters because exposure to many companies does not guarantee exposure to the most important outcomes; a few percentage points in a huge winner can be worth far more than many small positions. Follow-on reserves are both offensive and defensive: they protect ownership in downturns and allow managers to lean into their best companies when the market is cautious. LP diligence should focus on ruling out weak firms rather than pretending it can reliably identify the future stars of venture. Firm succession and partnership renewal help preserve persistence; top VCs must keep bringing new talent into the firm while retaining institutional knowledge. The industry is likely to contract from today’s high number of managers, because fundraising, liquidity, and LP expectations are all under pressure. Premium fees are justified when net performance is exceptional, because in a power-law industry the upside can outweigh higher carry. Top founders want to work with investors who push them hard and have relevant pattern recognition and reference networks; winning competitive deals is often the key differentiator.

Data Points: Managers backed over 30 years: 110 - Approximate number of venture managers Vencap has backed over three decades. Median return of those funds: <2x - Median performance for all 110 managers backed by Vencap. Portfolio companies analyzed: 11,000+ - Underlying companies in Vencap’s early-stage fund data set. Early-stage funds analyzed: 259 - Funds included in the Vencap return study. Share of companies that failed to return capital: >50% - More than half of backed companies did not return invested capital. Share of companies that became fund returners: ~1.1% - Only a little over 1% of companies returned the capital of the fund that backed them. Largest single fund-returning multiple: ~27x - Highest fund returner in the data set returned about 27 times the fund invested in it. Portion of 3x net funds with a fund returner: 90% - Most early-stage funds delivering 3x net returns contained at least one fund-returning company. Core manager capital concentration since 2010: 90% - Share of capital allocated to just 12 core managers since 2010. Core manager portfolio size: 12 managers - Vencap’s core repeat-fund manager group. Performance of core-manager portfolio: >3.5x - Reported aggregate performance of the co-manager/core portfolio. Top-quartile persistence for next fund: ~45% - Tim Jenkinson research cited by Clark on venture fund quartile persistence. Top-quartile / bottom-quartile mix for core managers: ~50% top quartile, <10% bottom quartile - Observed distribution of outcomes among Vencap’s core managers. Core manager capital allocation timeframe: Three-year cycle - Vencap prefers to deploy capital across a roughly three-year investment period. Worst fund timing example: 1999 vintage, invested in 18 months - A fast-invested fund from the dot-com era was cited as the worst-performing fund raised. Typical ownership on first check: Low- to mid-teens % - Vencap’s typical initial ownership target for early-stage managers. Ownership at exit: High single digits, around 8%–10% - Typical dilution-adjusted ownership level considered powerful at exit. LP capital concentration in core managers: ~50 funds across a three-year cycle - The 12 core managers raise multiple funds, creating about 50 fund opportunities over three years.

Pivotal Quotes: "the median return for all of those funds was less than 2x. But there was a small group of managers within those 110 that were consistently able to outperform." — David Clark: Used to explain why Vencap focuses on repeatable winners rather than broad manager exposure. "the biggest predictor of whether a manager has a higher than normal likelihood of finding a fund returner is have they done it before." — David Clark: Clark’s central thesis on manager selection and persistence. "one of the other things that we have seen from our own data is that 90% of the early stage funds have at least one company that returns the entire fund." — David Clark: Supports the point that a single outlier can determine venture fund performance.

Implications: LPs should prioritize repeatable access, ownership, and disciplined pacing over trendy manager-count growth. In a cooling market, the best chance to outperform is to back proven GPs, reserve follow-on capital, and buy into quality counter-cyclically.