We held our latest panel debate entitled Venture Capital - Mainstream or For Adventurers Only? on 17th May 2022. Aoifinn Devitt hosted four panellists from both sides of the Atlantic for a discussion on whether or not institutions should allocate more to venture cap:
Andrew Elder: Deputy Managing Partner, Albion Capital
Modwenna Rees-Mogg: Founder at Funding Index
Leslie Lenzo: Chief Investment Officer at Advocate Aurora Health
James Brooke Turner: Investment Director at The Nuffield Foundation.
Venture cap continues to evolve
Venture cap has been an asset class for nearly 60 years but continues to evolve. One panellist said that when they first invested they hadn’t expected any return, but funded innovative companies as a public good. The latest cycle has seen a huge increase in volumes and managers, which at least in the view of some has increased quality and the options for investors. One big change compared to previous cycles has been the central role of tech in almost all venture cap.
Other panellists were more sceptical, especially about timing. The surge in volume has led to ‘tourists’ who have ended up paying too much: since the downturn in public markets, some on the panel believed private asset valuations are likely to come down too. The new competition has led to all investors having to invest at least one stage earlier in order to secure access to good investment opportunities.
Return and risk in venture cap
That led to a conversation about returns, risk, and diversification. Most venture cap investments will return close to zero, a few will return their capital, and only about 10% will actually deliver a positive return, let alone the eye-popping ones which hit the headlines. One panellist suggested that a successful pre-seed investment needed to return about 10x the money invested to make the model work.
Different investors have different risk appetite. Some prefer to invest in later stage venture cap where the returns are lower, perhaps multiples of 3-5x, and the time-scales shorter. Another cited a fund with a lower risk and return profile where 75% of the underlying companies had more than returned their capital.
We discussed whether diversification can help institutions mitigate the specific risk arising from the binary nature of venture cap outcomes. A suggestion was made that a portfolio needed at least 500 underlying companies and the more diversification the better. Others commented that the governance resource needed for this was costly, and that diversification on its own would not guarantee success – it was quite possible to pick a portfolio of 500 duds. Some on the panel preferred a more concentrated portfolio of companies which they could focus on and support, or where they could get additional value or knowledge in specialist areas.
We then turned to resourcing. All agreed that most institutions will need to use specialist managers for at least part of their portfolio. This is partly about lack of expert knowledge and available resources, but also about access to good deals. That does not necessarily mean the very top returning venture cap managers, where the cost (fees and other) is often too high. The panel acknowledged that the spread of manager outcomes is wide, and selection is another hurdle for institutions.
Impact’s role in venture cap
We discussed the Government’s levelling up agenda and whether impact was an essential part of venture cap. One panellist commented that the G of ESG (i.e. governance) is the key to getting this right. Venture cap managers have a great deal of influence when providing funding and as they help companies shape their future. If a company is providing a double bottom line i.e. social impact as well as financial return, it is likely to do well for investors anyway. Another panellist was clear that while impact is important to them, it is part of their process rather than an objective in itself: they do not design portfolios or investments around the impact they make.
Exit routes
We finally looked at exit routes for investors. Trade exits are far more common than IPOs, and at least in Europe IPOs often ended up leading to trade exits. One panellist highlighted the huge increase in secondaries markets and how they can provide quicker exits for investors. She also touched on the growth of private markets which aim to match sellers and buyers of illiquid investments. At the moment liquidity in these is low, but they are growing.
The future for venture cap
As we looked ahead, the point was clearly made that inflation matters, and will change the dynamics of venture cap, probably in favour of the underlying companies and away from investors. The panel generally believes that there are plenty of upcoming opportunities to soak up the money coming into the sector. The big question is the valuation at which the two will meet.
Returning to the title of the talk, we generally concluded that, partly because of the need for innovation, partly (in the U.K) because of the Government’s levelling-up agenda, it will be hard for investors not to make an allocation to venture cap. However, the barriers for large and lightly resourced institutions remain high. Could tech come to the rescue?