By TOMIO GERON (Wall Street Journal)
When entrepreneur-investor Dave McClure launched his seed fund and accelerator 500 Startups in 2010, he was perhaps best known for his colorful, opinionated blog posts about startups.
The West Virginia-born former PayPal executive had sold a technology consulting firm and successfully seeded startups for Founders Fund. But 500 Startups, with its unconventional large-portfolio approach and brash style, was still an outsider in the button-down world of venture capital.
And although many firms have reshaped venture capital in recent years, Mr. McClure remains a maverick in the industry. Last year, he told The Wall Street Journal that large limited partners were still wary of investing in his firm.
Now he’s seeking more respect, and 500 Startups has gone so far as to reveal its detailed return fund performance data to help make the case.
Venture firms typically keep such information a closely guarded secret. But Mr. McClure tends to share more—just as he does on social media.
So why is he disclosing confidential data about the firm now?
“Because our results are very good,” Mr. McClure said. “I’m not sure if they know (about our returns) or not, but I want make it super-clear.”
Mr. McClure’s theory, unlike traditional firms, is that a venture-capital firm can stretch to a larger scale. His firm, now with more than 125 employees, has invested in about 1,500 companies, 259 companies of them in Fund I.
Founders Fund investor Peter Thiel’s “power law” in venture capital holds that one “home run” investment that returns an entire fund is an ideal outcome. Accordingly, firms should invest in fewer companies.
Mr. McClure says his math upends that thesis. A typical venture fund with 50 companies counts on one massive outcome to return a fund. “If I have 250 companies, I can see five (big exits),” he said.
The firm’s first fund is in the second quartile compared with all U.S. venture capital funds, while the second and third funds are in the first quartile, measured by total value to paid in capital, or TVPI, according to data from Cambridge Associates. TVPI is an investor measure of current return on investment in a fund.
Fund Close Date Net IRR Peer Median TVPI Industry average
Fund I ($29.4M) 2010 18.5% 22.12% 2.05x 2.14x
Fund II ($45M) 2012 23.1% 14.92% 1.66x 1.41x
Fund III ($85M) 2014 20.3% 0.61% 1.18x 1.01x
Source: Cambridge Associates
Of the firm’s three funds since 2010, the most recent fund has performed best when compared with industry peers. The firm’s first fund, a $29.4 million 2010 vintage vehicle, has a net internal rate of return of 18.5% as of the end of 2015.
500 Startups is now raising its fourth fund, targeting $150 million to $200 million and has raised about $50 million so far, according to a person familiar with the matter.
To match a traditional firm’s “home run” exit, Mr. McClure says 20 of Fund I’s 259 portfolio companies will achieve medium-size exits with a $100 million valuation. And he expects three to five large exits such as an IPO—in addition to Twilio Inc., which went public in June. That would be 8% to 10% of companies with “meaningfully large” outcomes and 1% to 2% that could be valued at $1 billion or more.
“That’s nowhere near as concentrated as a traditional VC fund, where one or maybe two drive the entire fund, Peter Thiel’s power law notwithstanding,” Mr. McClure said. “That’s from a portfolio of 50 companies or less. That’s not necessarily wrong. It’s just not large enough of a data sample.”
One limited partner says the approach works. “The data shows it’s a very quantitative approach that’s both scalable and repeatable,” said Court Coursey, managing partner at Tomorrow Ventures, Eric Schmidt’s venture firm, which invested in all three 500 funds. “It does work if you have enough doubles and triples.”
Before co-founding 500 with former Google executive Christine Tsai, Mr. McClure was a seed investor at Mr. Thiel’s firm, Founders Fund. There, via FF Angel and via fbFund, a joint venture with Accel Partners, he funded companies that generated large exits or gains such as Twilio, Zimride (now named Lyft), CreditKarma, SendGrid and Wildfire. Mr. McClure’s FF Angel investments, which don’t include fbFund, turned a $2.7 million fund into $103 million in value, before the recent Twilio IPO, according to a person familiar with the matter.
“McClure’s returns while at Founders Fund are exceptional and rank near the top of any seed investor over the past five or six years,” said a limited partner in venture funds who isn't an investor in 500. “His performance at 500 Startups to date is solid, but isn't yet truly exceptional.”
Most Silicon Valley firms prefer to invest with entrepreneurs in close proximity in the belief that this is the best way to find successful exits. But 500 Startups has emphasized investing in international companies.
Its international deals compare well to its U.S. deals. In Fund I, 39% of the fund’s investments were outside of the U.S. International companies—including companies that moved to the U.S.—are now valued at close to 6 times their invested capital and represent 56% of Fund I’s gains.
Three of the five top companies in Fund I by gain were founded outside the U.S.: online education startup Udemy, which has raised $173 million, call center software outfit Talkdesk, which has raised $24 million, and customer service startup Intercom, which has raised $115 million.
“The thesis was there’s 6.7 billion people who don’t live in the U.S. and internet growth rates and penetration are rising outside the U.S.,” Mr. McClure said.
The top three U.S. companies from Fund I are MakerBot, Twilio and Womply. The firm also invested in the Series B and C rounds of Twilio.
Its accelerator companies also have had positive results. One-quarter of its Fund I dollars were invested in accelerator companies and those companies represent about one-third of the fund’s gains.
“Because (500’s) model is a little different, it has taken longer to prove itself,” said Jason Lemkin, who recently raised $70 million for his own fund. “I do think it has mostly proven itself at this point. Maybe one of 500’s biggest assets is how strong it is internationally. The further you get from the San Francisco Bay Area, the existing ecosystem gets dramatically weaker.”