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When it comes to venture capital investing, it pays to think small and boring.

That seems to be the lesson from a rare inside look at the track record of one of Silicon Valley’s most prominent software investors. Set up 17 years ago by a former basketball star and a software veteran, Hummer Winblad has racked up a compound internal rate of return of 41 per cent for anyone lucky enough to have been with it from the start, according to data shown to the FT.

During that time, though, it has also foundered on some of the technology industry’s biggest follies, including making nearly $300m worth of investments at the time of the dotcom boom that have so far brought returns of only $21m. It has also seen a general deterioration in its returns as the scale of its investments has grown.

The insight into Hummer Winblad’s investment record comes at a time when some in the VC world have started to question whether their industry’s prospects have changed permanently for the worse. According to this view, too much capital has flooded into VC funds, making it unlikely that the industry will ever return to the heyday it experienced for most of the 1990s.

John Hummer, who played basketball for the Seattle SuperSonics before turning to finance, gives short shrift to that argument. However, he concedes that his own firm’s record shows that investment discipline can suffer when VCs are under pressure to put large amounts of money to work. He also says that Hummer Winblad’s next fund will be smaller than its previous two, which raised $300m and $400m respectively.

As private partnerships, VCs do not normally disclose their investment results. But Hummer Winblad said it was prompted to release some data to the FT after conducting an analysis of its investment history to better understand its track record.

The clearest lesson, according to Mr Hummer: the smaller the investment, the higher the eventual return from early-stage companies. The average investment made from the firm’s first two funds, between 1989 and 1997, was for less than $2m: that climbed sharply in subsequent years, with the average investment in consumer software and services companies reaching more than $11m during the dotcom bubble. Few software companies ever reach a size that justifies large up-front investment, says Mr Hummer. As an example, he points to Employease, a company in which HW first invested in 1998, and which was sold to data processing giant ADP last year for around $160m. Though eventually a success, HW had to nurse its investment through several years during which Employease’s privately assessed value tumbled from more than $130m to under $20m. The big gains from investments like this also have to offset lower returns or losses on other companies.

A second lesson from the HW figures is that boring may well be good. Like other Valley financiers, it chased high-profile consumer investments at the end of the 1990s, most prominently an investment in music network Napster, which was later forced to close. The consumer investments have shown a negative internal rate of return of 31 per cent.

At a time when VCs are once again caught up in a stampede to invest in consumer internet companies, that should give pause for thought. For every YouTube, which proved a hit for venture capital backer Sequoia Capital, there are many others that will fail, says Mr Hummer.

By contrast, the seemingly dull business of infrastructure software – used to run the guts of big IT systems – has yielded stellar returns, with the 32 companies HW has backed in its history producing a rate of return of
97 per cent.

HW’s first two funds caught the boom in client-server computing, as the rise of the PC stimulated demand for a new class of software.

While HW’s latest fund, started in 2000, still shows a negative return on paper, it looks set eventually to wipe away the poor returns of the previous two.

VCs do not count the profits from their investments until companies either go public or are sold, and of the 47 companies in which it invested, 28 are still active and carried in its books at cost, the firm says.

Copyright The Financial Times Limited 2017. All rights reserved.
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