Cross-border innovation, Forum

A New Venture Capital ?

Reprinted with the permission of Udayan Gupta and Tom Darling These are heady times for the venture capital industry.  Record exits, record investments and record fundraising. More important, investors – many skeptical of venture capital as a legitimate asset class – are coming back to the industry.   Not the largest ones such as Calpers but many smaller ones – small college endowments, smaller pension funds and, most significant, wealthy individuals and family offices from within the US and abroad. “It’s a more rational market,” says Andrea Auerbach, managing director and global head of private investment research at Cambridge Associates.  “Lessons have been learned. The Internet boom of the 2000s caused a surge of capital that inflated valuations and subsequently lowered returns.  And while the present boom creates the temptation to flood the market with new capital – a reprise of the early 2000s — it hasn’t happened,” she explains. This is not a venture capital renaissance by any means.  But the numbers suggest that the industry is not just all about a few titans that pump up the volume but about a diverse community of venture capitalists that is beginning to find its own niches and strategies and marketing to the appropriate investors.   Still, the numbers are at the heart of the re-emergence. Venture capital funds are making money. Venture capital firms realized $105 billion worth of investments in portfolio companies during the first three quarters of 2014, higher than in any other entire year in the period since 2007, according to Preqin, a UK based provider of alternative assets data. And they’re investing money too, adds Preqin. More capital was invested in companies by venture capital firms in the second quarter than in any other quarter, with $23 billion of funding across the quarter. Alongside, corporate venture funds are investing in record amounts. Corporate venture funds invested $993.6 million in 176 deals to U.S.-based companies during the third quarter of 2014, according to the MoneyTree Report from PricewaterhouseCoopers LLP (PwC) and the National Venture Capital Association (NVCA).    Indeed, corporate venture accounted for 10.0% of all venture dollars invested and 17.2% of all venture deals in the third quarter, marking the strongest quarter of 2014 as a percentage of total venture investing. One hundred and sixty corporate venture groups invested almost $3.3 billion in 562 deals through the third quarter of 2014, representing 9.3% of total venture dollars invested and 17.7% of all venture deals. The venture economy also benefited from the overall surge in M&As. 127 U.S. based venture-backed companies were acquired for $20 billion, the highest quarterly amount since 2000.  Facebook, Cisco and Google were among the most prolific buyers and continue to be among the most likely suitors for every major deal. Perhaps most important, investors are returning to the venture capital industry.  To date, venture capital funds have raised $38 billion   surpassing the $31billion raised by 274 funds that closed in 2013. And more than half (56%) of venture capital investors surveyed in October 2014 said they would make their next commitment to a venture capital fund by the end of 2015.

“The internationalization of venture capital applies also to investors,” says Tom Darling, a senior advisor to venture capital funds and a former Citicorp fund manager. Chinese and Indian investors with excess capital are diversifying from their native funds into the US market in particular. Firms like WI Harper Group in Beijing have played a “bridge” role since the late 1990s; now they are players in both directions between China and Silicon Valley, says Darling.
Just a year ago, institutional investors, many desperate for cash to meet current obligations, would ask venture funds how quickly they could make distributions.  And in the process they screened out smaller funds and those that were early stage.   But with the stock market at record highs, investors in the industry are more focused – long-term investors who understand the illiquidity of markets and illiquid strategy that drives venture capital, says Auerbach of Cambridge Associates.  Investors are seeking out more focused and specialized funds and are a lot more realistic about investment horizons. Specialist consumer-focused, financial services-focused, health care-focused and technology-focused funds outperformed generalist funds, says Cambridge Associates. In response, venture capitalists are designing smaller specialized funds that display their own strengths and also recognize investor needs for a range of returns, says Darling.  So, Benhamou Global Ventures, a technology fund launched by Eric Benhamou, a former CEO of 3Com and a number of Silicon Valley high-tech businesses, is selling his domain expertise and a shorter-term investment scenario:  “I will invest in A rounds and sell them as C rounds.”
Benhamou says that his fund tries to combine his and his teams’ operating experience and cross border sourcing.  “BGV is designed to take advantage of technology’s globalization, with representation in Silicon Valley, Northern Europe and Israel, all sources of the new IT technologies of cloud, cyber security and Internet of Things,” he adds.
The shorter return duration and the small fund aren’t necessarily for large institutional investors but it is playing well with smaller investors who want a piece of new technology ideas and are quite comfortable with the values they can create in the private space, explains Darling. Some venture funds are adopting a rollout model that traditionally has been the stock-in-trade of small buyout funds.  New York’s Ravi Suria, a former Wall Street analyst and a hedge fund manager, has created Vaishali Capital, an investment fund which invests in small innovative ideas, builds them out and then brings in investors to grow the idea and create scale. The initial deal flow of Vaishali (named after one of India’s legendary ancient Eastern cities)  will come from  a  biosciences based skincare incubator  that will develop and commercialize  medically or scientifically derived patented molecules, delivery systems and devices for overall health, wellness and anti-aging benefits primarily in the non-Rx consumer sector. Suria also is targeting smaller investors and family offices because traditional advisors and consultants still are sticking to brand funds, unwilling even to vet the smaller and usually more innovative funds. All of this experimentation with ideas and investors comes at a time when big investors say they want to scale down. Some of them feel that the bigger funds simply cannot deploy more capital or produce better returns. So large funds such as CALPERS says they will reduce their exposure to venture capital. Over the next ten years it will reduce its venture exposure to 1% of its total private equity portfolio – down from 7% now. “The Achilles Heel for venture capital funds since the turn of the millennium has, of course, been performance. Returns have generally been lagging well behind other private equity strategies, but despite this, many investors have stuck with VC,” writes Chris Elvin, head of private equity products at Preqin. But now that the IPO markets are open, there’s a strong M&A environment and returns are up, the industry may once again be gaining back the relevance it seemed to have lost.