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Ashby Monk, Ph.D., executive director of the Global Projects Center at Stanford University and a senior research associate at the University of Oxford, has been blogging about sovereign and pension funds since 2008. 

Follow him on Twitter at @sovereignfund.

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When it comes to investing edge: Advantage, Giants.



Bringing Scale to Venture Capital

The great irony of the venture capital industry is that it is uniquely capable of helping entrepreneurs scale their businesses, but it hasn’t found a way to scale itself. This stems from the fact that VC is a relationship and services business founded on high-touch interaction with entrepreneurs through trusted (and hard earned) networks. It’s hard to scale this type of activity, which is why some of the best VCs are adamantly against scaling their own firms; purposely keeping fund sizes small in order to focus on their core area of expertise: helping entrepreneurs launch and build companies.

While laudable, this “keep-it-small” mentality means that traditional VC mandates are rarely big enough to be meaningful for the largest institutional investors in the world. Put simply, the allocation a pension fund or sovereign fund gets from a top VC won’t move the needle on returns even if it is hugely successful. And, as a result, a growing number of large institutional investors are now asking themselves, “What’s the point? Why am I still investing in this asset class?”

As it happens, I came up to Suncadia (where I am typing this post) to speak at the WSIB’s annual offsite and do my best to answer these questions. I came up here because I believe there’s an opportunity for smart, large institutional investors (e.g., WSIB) to re-engage with the asset class in a meaningful way. I think we can bring scale to VC – which is another way of saying that I think we can make VC work for large institutional investors.

But it requires a reconceptualization of the VC ecosystem and the role that the Giants (LPs) and asset managers (GPs) play therein. Too many Giants want VC to be easy. But as I see it, making VC work for a large institutional investor requires far more than writing a check to Sand Hill Road and then crossing fingers. It requires meaningful engagement with the asset class and the companies therein. Let me give you some examples of what I mean:

- In-House: A few Giants are bringing VC in house, and the one that stands out in my mind is Omers. It has a 14-person team doing direct VC deals in the USA and Canada. They’ve made 15 direct investments or so since launching a couple of years back. And they’re making a name for themselves as the “go to” VC for Canadian entrepreneurs. Personally, I think this is an attractive model because you can solve for the time horizon problem and can continue to invest in the portfolio companies as they ramp (thereby solving the scale problem). Conceivably, the big winners coming out of the venture portfolio could be seamlessly passed into the public equity portfolios and even handed off to fixed income teams.

- Seeding: Some Giants have taken to seeding new managers in order to get the alignment of interests and scale they want from this asset class. And the example that jumps to mind in this case is the Wellcome Trust, which recently seeded a $325 million venture capital business that will back biotechnology startups. The new outfit is called Syncona Partners, and it’s being structured as an “evergreen investment company.” This approach offers many of the benefits of an in-house VC practice, while still offering the flexibility required to attract top talent. In addition, I think this specific vehicle is particularly interesting because it leverages the unique skill set of the Wellcome Trust, which is a charity entirely focused on health care. As such, building a venture practice around healthcare is probably quite smart from the perspective of asymmetric information and deal flow.

- Creative Collaboration: I think VCs have realized (painfully) that there are certain industries for which they lack the necessary resources to take a portfolio company all the way to full commercialization. As I see it, this is a good thing as it presents a lovely opportunity for intrepid Giants to work collaboratively with VCs to help scale certain types companies in capital-intensive industries. For example, at Aimco we spent a lot of time thinking about the industries where we felt we could add the most value, and we settled on energy, materials and agriculture. We then developed some deep relationships with a hand full of VCs to source direct deals in these specific areas. We like to believe that this partnership with the GPs is a division of labor in that the VCs de-risk the tech and then we step in and actively help the company achieve commercial scale. There are no fees as part of these relationships. Win-win. What makes this model work, however, is not being naïve about the GPs motivations. This “partnership” only works if we have the in-house talent to properly vet all of the opportunities that the VCs bring to us. (If we don’t, then we’re getting into some serious principal agent problems and potentially helping VCs salvage their dogs, which is clearly not what we want to be doing.) And so it’s with this in mind that we’ve teamed up with some of our peer SWFs, pooling our venture resources into a single cohesive team. We run in-bound opportunities through this team and focus on executing a rigorous and meticulous evaluation of the opportunity. So far, this creative collaboration... with our peers and with GPs... has been quite rewarding. But it’s still early days.

To sum up, making VC scale – making VC work for Giants – necessitates some fairly innovative and forward-looking strategies. And whether it’s an in-house portfolio, seeding a new manager, or working with peers and managers in creative ways to back growth stage companies, Giants have to have highly sophisticated staff and a deep understanding of where they can add value to a VC investment.

In short, without the in-house talent capable of doing something creative in this domain... VC won’t scale. So if you don’t have the talent, perhaps you’re right to leave VC to others. But if you have that talent or can get it, this is a remarkable time to be expanding into VC then there are huge opportunities right now.