The future of much of the venture capital (VC) world has been laid out this week – appropriately enough from a firm named after the Greek goddess for communication.
State-backed investors and corporations teaming up to provide capital for teams to invest in entrepreneurs is the new world order. Its highlighted by the €300m ($400m) commitments to France-based Iris Capital – formed out of its state/quasi corporate venturing backer, CDC Groupe – by local advertiser Publicis Groupe and phone operator France Télécom-Orange.
But its being replicated in plans by US drugs group Eli Lilly’s Mirror fund mandate to go to TVM, Oxford Capital Partners’ introduction of a corporate venturing fund shortly, as well as private equity firm TPG Capital looking to corporations to cornerstone its $500m clean-tech fund. (All parties declined to comment.)
The past 30 years’ bubble in venture of institutional investors (pension funds, life assurers, banks) as limited partners in VC funds was spawned by American regulatory change in 1978 and the tail wind of baby boomers looking to equity for its savings and relying on financial services providers to still be around when they wanted to retire.
Its hard to imagine any 20-something saying the company they work for or save with will still be in existence in 70 years as a default position or that the state will provide a lifestyle where they can work for such a short amount of time as baby boomers have done. If this is the case, soveriegn wealth fund-enforced savings, along with corporations (and the individuals grown rich from them such as chief executives and direct shareholders), become the main repository of capital to allocate to productive parts of the economy.
The problem for most VC firms in their fundraising difficulties is similar to why most VC firms are terrible at their core job of deal making: they rely on pattern recognition from the past rather than looking at how the world changes and what needs to be done to be successful in the future. Most still look back at how to get commitments from institutional LPs rather than the next generation of investors.
And on dealmaking, from TPG’s repeat investment in Washington Mutual during the credit crisis – after earlier success by private equity founder David Bonderman in the 1990s from the Savings & Loans debacle when he sold American S&L to WaMu – through to endless VCs saying they look for managers or situations that remind them of previous wins it is usually a heuristic mistake based on laziness.
The problem is most limited partners encourage such laziness because of their own behavioural troubles in encouraging change and desire to tick boxes based on past patterns. Investors are likely to do far better in looking at how to avoid group-think and seeing ways to take advantage of the next generation of opportunities than in trying to find the same sectors that did well historically.
If private equity is about finding lucky managers in the right sector at the right time (or vintage), such as technology in 1984 or biotech in 1993, then turning to traditional managers from a previous age is unlikely to do well unless they are showing how their skills can be replicated in new areas – which is easier done in practice now given the large amounts of data and information to see patterns and why the cross-sectoral and regional innovation trends are so interesting, such as how physicists effectively created biotech or how semiconductor engineers are redefining the world of medical technology.
But it also requires a reshaping of core assumptions. Economics appears more as a branch of behavioural finance built on psychology but dressed up by business schools as its own discipline and focused on rote application of ratios to real-world requirements. The clash of business school managers using short-term discounted cash flow analysis and relative profitability to decide future investments versus states and businesses that look at broader measures of wealth and asset creation is perhaps one of the biggest incipient challenge of our times.
Iris Capital’s funding, therefore, reflects a world order where hyping of internal rates of return by a quick cash exit and quarter-by-quarter changes to strategy are less necessary but the skills built in building businesses and asset values can be funded by parties that are looking at a broader picture.