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Market Chatter: It’s Always Sunny on Sand Hill Road

November 7, 2017 / by Bradley Rowbotham, CAIA, Research Analyst, Private Equity and Timothy F. McCusker, FSA, CFA, CAIA, Chief Investment Officer, Partner

 

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In October, NEPC paid an extended visit to the Bay Area to assess the current investment landscape for venture capital. Our goal: to continue building relationships with premier venture capital managers in order to identify funds for further due diligence and potential allocations to client portfolios.

Given the concentration of managers in Silicon Valley, we had over a dozen meetings, ranging from seed- and early-stage managers to seasoned special-situations venture veterans; we also met with a venture-lending manager.

Our discussions were varied and rich, running the gamut from the investment environment, to specific investments across enterprise software and consumer technologies. We even heard from a venture manager with a budget-based management fee approach, where the fees reflect the amount of time and capital committed within each fund; the fees ranged from 0.5% in the early and late years to a peak of 2% in the most active middle years. We found this to be a refreshing approach in a capital-constrained asset class where discounts and lower fees are hard to come by. 

Given the focus on venture capital for many of our clients, and the widespread prevalence of venture-backed companies in not only capital markets, but also in our day-to-day lives, we thought it would be useful to summarize the following key themes from our meetings.

SoftBank is here

The SoftBank Vision Fund, unveiled in October 2016, is a $93 billion fund targeting technology- and artificial intelligence-focused enterprises that are expected to be a part of a global shift towards automation across industries. Already, the fund has put over $20 billion to work. During our trip, conversations were rife with speculation of a large-scale investment by the Vision Fund in Uber. 

Some view SoftBank’s presence as a major challenge, fueling frothy valuations; others see it as a unique provider of large-scale liquidity for major venture-backed companies, allowing them the flexibility and autonomy that comes with remaining private.

Only time will reveal the fate of Vision Fund’s initial investments and its future ones. The one thing we are certain of: the venture-capital world is watching. 

Corporate Venture Offices

Long-term venture-capital investors are familiar with the milestones of an investment cycle. A sign of potential overheating: the arrival of so-called tourists. This uncomplimentary term in the venture capital ecosystem refers to fresh ill-informed money not likely to withstand the test of time. The latest wave of tourists consists of corporate-backed venture-capital offices with companies seeking to put their excess cash to work in the hopes of earning higher returns and finding new technologies that may align with long-term business initiatives. Despite their good intentions, these offices often get the cold shoulder from the venture-capital community because of their lack of connections, mismatched objectives, and high staff turnover. To be sure, the emergence of these offices is but one data point. That said, it is likely signaling towards a market closer to its top than bottom. 

A Thawing IPO Market

Initial public offerings have been limited since 2015 with venture-capital managers expecting an uptick in activity. Many startups are healthy and ready for capital infusion from public markets as early-stage investors and founders seek liquidity. However, companies may choose to stay out of the public view for a while longer in an attempt to avoid value depletion, as seen with Snap (SNAP) and Blue Apron (APRN) as early misses on revenue targets lead to scrutiny from public markets. To this end, the Vision Fund may provide an alternate source of liquidity in this area of the venture-capital world.

New Technologies are here to Stay

While venture capital has had an incredibly long and strong run, the optimism across managers was pervasive. Investors expect continued innovation and breakthroughs in enterprise software, cybersecurity, and data and analytics. Additionally, investors predict big things in the future on the consumer side—despite big disrupters such as Amazon and small ones, for instance, Stance.com and Dollar Shave Club—as still less than 15% of US retail sales occur online.

During our conversations, some felt frontier technologies, for instance, self-driving cars, drones, virtual/augmented reality, were unsuitable for some investors because these technologies are still in their nascent stage. However, others were bullish on the potential impact and upside of these enterprises as they are likely to impact our lives at some point.

Needless to say, managers and investors that can identify and allocate to the winners within each space will reap rewards. By the time these frontier technologies become omnipresent and commonplace, the largest returns on investments will have already been reaped.

Premier-Venture Capital Managers are open to New LPs

Access to well-respected venture capital managers is also opening up. There is a new generation of highly-regarded managers that value the benefits of a diversified and frequently refreshed roster of limited partners. This is all the more relevant in light of the financial crisis when some venture-capital managers were burned by cash-strapped endowments. Many of the managers we spoke with feel it is healthy and appropriate to free up a portion of capital for new investors for each new fund. To this end, we are optimistic of the relationships we are building and we look forward to presenting our clients with opportunities to allocate to some of these managers in the future. 

As investment consultants, it is our job to approach strategies with a healthy dose of skepticism as we analyze the real drivers of returns. That said, it was refreshing to be in the company of these venture-capital managers and to hear their optimism about the companies they own and the technologies they see emerging. We believe there will be continued opportunities in this space as managers with great reputations among entrepreneurs and those that have demonstrated skill in identifying deals bring successful new technologies and solutions to the marketplace. 

Topics: Research, Market Chatter, Endowments & Foundations, Private Wealth

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