Venture Capital Reemerges with a Tighter Focus on Investors

The asset class isn’t for everyone. But some investors are again flocking to its longer-term, if illiquid, promises.

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Cisco Systems Inc. signage stands at the company’s headquarters in San Jose, California, U.S., on Friday, Aug. 15, 2014. Cisco Systems Inc. Chief Executive Officer John Chambers is struggling to revamp the world’s largest networking-equipment maker, eliminating 6,000 jobs in a new round of cuts and forecasting little to no sales growth. Photographer: David Paul Morris/Bloomberg

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These are heady times for the venture capital industry, with record exits, investments and rounds of fundraising.

More important, investors — many skeptical of venture capital as a legitimate asset class — are returning. These include not necessarily the largest ones, such as the California Public Employees’ Retirement System (CalPERS), but many smaller ones, such as small college endowments, smaller pension funds and, most significant, wealthy individuals and family offices from the U.S. and abroad.

“It’s a more rational market,” says Andrea Auerbach, managing director and global head of private investment research at Cambridge Associates in San Francisco. “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 says.

This is not a full-blown venture capital renaissance. But the numbers suggest that the industry is not just about a few titans who pump up volume but about a diverse community of venture capitalists who are beginning to offer their own niches, strategies and marketing to appropriate investors. Still, the numbers are at the heart of the reemergence of venture capital.

Venture capital funds are making money. These firms realized $105 billion worth of investments in portfolio companies during the first three quarters of 2014, higher than any year since 2007, according to Preqin, a U.K.-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.

Meanwhile, corporate venture funds are investing in record amounts, some $993.6 million in 176 deals to U.S.-based companies during the third quarter of 2014, according to the MoneyTree Report from PricewaterhouseCoopers and the National Venture Capital Association. Indeed, corporate venture accounted for 10 percent of all venture dollars invested and 17.2 percent of all venture deals in the third quarter, making that the strongest quarter of 2014 as a percentage of total venture investing. Some 160 corporate venture groups invested almost $3.3 billion in 562 deals through the third quarter of 2014, representing 9.3 percent of total venture dollars and 17.7 percent of all venture deals.


The venture economy also benefited from the surge in M&A. Some 127 U.S.-based venture-backed companies were acquired for $20 billion, the highest quarterly amount since 2000. Facebook, Cisco Systems and Google were among the most prolific buyers and continue to be among the most likely suitors in every major deal.

Perhaps most important, investors are returning to the venture industry. To date, venture capital funds have raised $38 billion, surpassing the $31 billion raised by 274 funds that closed in 2013. And more than half (56 percent) 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, founder and head at ChinaBridge Capital and a former Citigroup fund manager. Chinese and Indian investors with excess capital are diversifying from native funds into the U.S. market in particular. Firms like WI Harper Group, headquartered in San Francisco and with offices in Beijing and Taipei, have played a “bridge” role since the late 1990s; now they are working the traffic in both directions between China and Silicon Valley, says Darling.

A year ago institutional investors, many desperate for cash to meet obligations, would ask venture funds how quickly they could make distributions. In the process, they screened out smaller funds and those that were at an early stage. But with the stock market at record highs, venture investors are more focused; they are long-term investors who understand the illiquidity of markets and illiquid strategies that drive venture capital, says Auerbach of Cambridge Associates.

Investors are seeking more focused and specialized funds and are a lot more realistic about investment horizons. Specialist funds — those focused on consumer, financial services, health care and technology — have outperformed generalist funds, according to Auerbach.

In response, venture capitalists are designing smaller, more specialized funds that showcase their strengths and recognize investor needs for a range of returns, says Darling. So, Benhamou Global Ventures, a technology fund launched by Eric Benhamou, who has sat on boards of many other Silicon Valley tech companies, is selling his domain expertise and a shorter-term investment scenario. “I will invest in A rounds and sell them as C rounds,” he says.

The shorter-return duration and the small fund aren’t necessarily for large institutional investors but work well with smaller investors who want a piece of new technology ideas and are quite comfortable with values they can create in the private space, says 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 hedge fund manager now at fund management firm Valmiki Capital Management, has created Vaishali Partners, a fund that invests in small innovative ideas, builds them out, 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 cities) will come from a biosciences-based skin care incubator that will develop and commercialize patented molecules, delivery systems and devices primarily in the nonprescription consumer sector.

Suria is also targeting smaller investors and family offices because traditional advisers and consultants are still 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. CalPERS, for example, says it will reduce its exposure to venture capital to 1 percent of its total private equity portfolio, down from 7 percent now. And other large pension funds and endowments also say they will reduce exposures.

“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 Christopher Elvin, head of private equity products at Preqin.

But now that the initial public offering 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.

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