A Look at the Current Environment for Limited Partners and Venture Capital

What a year it has been so far…a global pandemic, social justice movements, wildfires, and overall an incredible amount of change in 2020. So what does the world look like from a fundraising perspective for venture capital? Have things slowed down given all these external factors? On a recent webinar we discussed the current landscape and everything from becoming institutional ready for emerging managers to the future of corporate governance with experts in the world of Limited Partners (LPs) and corporate governance.

For investors, a close dialogue with portfolio companies is key right now. According to Jessica Baron, COO, SVB Capital, they haven't seen much delay for plans in going to market or a change of size of funds or pace of investing. There was a lull early on in the pandemic and a re-collaboration with companies and conversations about how to work going forward at a distance. Like many of us, she has adapted to Zoom meetings all day long and is beginning to see investments happening again now that we are comfortable with this new virtual format. She did note that SVB Capital is seeing more follow-on investing with a decreased rate of initial investments, although they didn't see a major fall off, as many had expected, in the March timeframe.  

Wells Fargo’s Tim Rafalovich, Head of Fund Investing Division, says that a dislocation has occurred. This upheaval enables groups that are savvy to think through opportunities that other groups have not seen. Certain industries (such as transport, hotel, and entertainment) that have been hit hard can also bring opportunities. This is visible in the talk of secondary discussions, which would not have happened before. The change can be seen in industries that people are moving in or out of that we haven't seen over the last ten years.

Companies that work from home are an indicator of success in this time.

Tim also shared with us some thought provoking takeaways from a recent Wells Fargo report on the economic impact of COVID and the work from home phenomenon. He said:

• Forty percent of smaller companies and venture capital (VC) firms may go out of business due to this new culture shift of working from home, while companies that are tech savvy may succeed or thrive.
• Supply chains are key -- especially those that are in a technology setting and are able to use their supply chain in a new way and or have some flexibility in this area.
• The strengths and weaknesses of a company prior to COVID is a definite indication of those that will do well versus those that will not do well.

This means that some of these VCs that were doing well before will continue to do well, maybe even grow and those that struggled before will struggle now to a greater degree. Tim manages about 70 percent private equity (PE) over venture capital and he says VC is a rockstar right now, performing very well vs PE. He notes this may be due to the fact that equity write downs may take place over time for VCs whereas PE firms took those right away.

The life of VC funds is growing beyond the previously expected lifespan.

We may need to take a longer term view on our portfolios as their lifespan grows notes Joncarlo Mark, Founder of the Upwelling Group. His firm recently did a study, in conjunction with Adams Street, to determine the life of the average fund which was 10 to 15 years pre-pandemic. The bottom line: more extensions of holding time of underlying companies affects the timeline further. One big theme right now is changes to the recycling provisions so that fund managers of full funded (9-10 year old funds, for example) can pull down more funds or proceeds that have already been distributed and allows them to address that situation without having to go to legal counsel and doing a lot of work. They can simply consent to change recycling provisions. In this scenario they don't need 100 percent consent. This can be both positive and negative for different cases. His two main things he’s seeing: The extension of fund life and the increased activity in the secondary market if they need more time, in addition to changes to recycling provisions, or hold back distributions. This may also yield a need for increased transparency and reporting.

Why does this matter right now? Joncarlo makes the analogy of a sailboat tacking in the wind. We are getting there but it's not a straight line, capital coming from the public into the private markets is significant, the average allocation in the year 2000 was three percent and it is four times that today. The number of public companies is half of what it was in the 1990s. With all of that money from those companies pouring into the asset class we shouldn't then be surprised by the increased scrutiny and transparency.

5 Questions to Ask to Determine Institutional Readiness

So with all this in mind, how do emerging funds ready themselves to be transparent and ready to accept institutional grade capital? Wells Fargo’s Tim Rafalovich, who heads up Fund Investing, has five questions that he asks to glean info about how serious emerging funds are about what they are doing and whether they're institutional ready:

1. What is comfortable is rarely profitable. How does somebody go after a market that others may not be  viewing and how are they going to look at that differently?
2. What are your bespoke theses -- a tailored look at your market based upon your backgrounds -- and how are you going to align those?
3. How does your group develop tacit, or less formal knowledge, and what do you know that others don't? How do you stand out?
4. How do you plan for a changing ethos in your team with this changing environment and technology changes? Life is moving on the technology side at Mach 7. That means that the ethos of your team needs to be adapting. What is your plan for doing that?
5. Why are you an investor and not just a speculator?

Tim says the answer to those questions in conjunction with showing an effort to become ready to meet compliance and governance aspects early on, shows how serious they are about what they're doing. If they are able to discuss regulatory and compliance topics which are typically addressed at five funds down the line, and they might be only at fund one or two, they are well positioned in the conversation.

What is the future of venture capital, according to SVB?

Jessica Baron, COO of SVB Capital, says that despite the challenges the economy and society have faced in 2020, she is excited about the future of venture. This means more deal flow and growing portfolios.

Relying on a spreadsheet tracker may not be enough though. There is also a movement to create a uniform reporting structure across a portfolio, which would be a dream come true for LPs. There is an effort afoot to provide the community to adopt a standard reporting structure. The experts here agree this is a good direction to head for tracking performance and economics of the fund, especially when considering fund life is 10-15 years or longer.