Limited partners used to have standard answers — usually something about above-par returns for patient investors and an early entry in the growth sectors of the future.
With venture returns for the decade now in negative territory, however, those reasons no longer sound so compelling.
Clearly, LPs are rethinking their venture strategies and overall commitment to the asset class. U.S. venture capital funds raised $1.9 billion in the second quarter of 2010, according to Thomson Reuters and the National Venture Capital Association — the lowest level of dollar commitments in nearly seven years. And while this quarter is shaping up a bit better, fund-raising is still well below pre-financial-crisis levels.
In September’s Venture Capital Journal cover story, “Choosy Shoppers,” I interviewed close to a dozen LPs and advisors involved in the fund-raising process to see what — in this exit-scarce environment — investors do like about venture. (VCJ subscribers can read the story here.)
A few strategies emerged. In some cases, LPs are taking a more hands-on approach to venture holdings. Case in point: Arizona State Retirement System, where private equity portfolio manager Richard Henkel says he looks for how companies and funds in which it holds stakes can benefit each other. This includes leading introductions between, say, a startup software developer and a mature, private equity-backed company that might use its application or even acquire it outright.
U.K.-based charity Wellcome Trust is taking a contrarian approach. Investments which take advantage of scarcer capital and disruptive economic conditions, Wellcome says in its annual report, are likely to be best placed. That’s why, the report says, more than 50% of the trust’s private equity investments are in venture capital funds and directly held venture investments, such as Pacific Biosciences, which recently filed to go public.
Others are looking to get in early on a sector or venture investment approach before the herd arrives. Chris Douvos, co-head of private equity investments for The Investment Fund for Foundations (TIFF), says early bets in the super angel space appear to be working out well. The challenge now is to figure out what will be the next hot space before others do.
And while limited partners overall may be investing less in venture, they are increasingly interested in educational programs about the asset class, says Scott Meadow, an entrepreneurship professor at the University of Chicago Booth School of Business who provides training courses for ILPA. That’s partly because, although they’re as fearful as ever about the risks associated with venture, LPs also worry about missing out on the next revolutionary technology.