Blurred Lines

Is it different this time around?

Scaling tech companies who stay in the private markets longer than anticipated is a well-documented phenomenon with some management teams and boards remaining averse to public scrutiny, while others know public market players won’t take the right time-horizon orientation in an evaluation of their company’s fundamentals. The consensus perception is that returns from technology growth have benefited private, rather than public, investors during the post-Recession bull run. I haven’t dug into the data, and perhaps what’s transpired in the markets may not fully reflect that overhanging belief, especially as you look at the performance of businesses like Twilio ($TWLO) post-IPO.

Here’s a look at Bessemer’s Emerging Cloud Index:

Regardless of the illustration of where alpha lies, there’s no doubt in my mind that capital forces are converging in the private venture + growth market. Traditional venture capital funds have moved upstream with broader capital bases, and institutional multi-asset players from the worlds of private equity and public markets have dipped their toes into growth, venture, and even seed investing. I’d like to explore why each of these investor cohorts are meeting each other, and the dynamics that come to fruition that mix with psychology, institutionalism, and cyclicality.

Platform Expansion

When Marc Andreessen and Ben Horowitz founded Andreessen Horowitz in 2009, they had a vision to flip the venture capital industry on its head. They spurned the model of the past, where individual GPs responsible for investments led the "value add" efforts — helping portfolio companies recruit, fundraise, meet customers, strategize, etc. Since then, they’ve expanded the definition of what it means to be a venture capital firm. A16Z’s first fund in 2009 was $300M — now their AUM sits around $10B across a host of vehicles. Other players in the venture ecosystem have also made similar moves to expand platform, which not only encompasses portfolio services, but the expansion of their assets and dedicated personnel:

I can think of a handful of reasons for the extension of capabilities. Some hypotheses include the necessity to contend with SoftBank’s war chest and capitalization requirements to scale companies globally. The macro environment also helps, so the money’s there for the taking. These massive funds now invest across seed, traditional venture, and late-stage growth. It’s not hard to rule out a future where they’re even involved with public market investing. From Matt Levine:

“Andreessen Horowitz could go buy huge stakes in public companies. Why would it want to? I don’t know; probably it doesn’t. But it makes a weird kind of sense. If private markets are the new public markets, then the stuff that venture capitalists learn in private markets should be applicable to public markets.”

The Downward Dip

From the vantage point of later-stage investors who operate in public markets or LBOs / PE, they’re looking at what’s happening in the technology sector and getting hungry to participate. I count Coatue, ICONIQ, Tiger Global, Two Sigma, Viking, Perceptive Advisors, Lone Pine Capital, H.I.G., Blackstone, Point72 as interested parties with dedicated efforts, among others. The introduction (or re-introduction as I’ll discuss later) of these firms changes the venture landscape dynamics on a few dimensions.

The AUMs are much higher in this world, so a lot of capital has to be put to work. It makes sense for some capital intensive companies that need to scale, but too much money can be detrimental to capital efficient businesses that could get withered down. Founders and early investors can also get heavily diluted with pervasive capital injections and late-stage ratchets + preferences.

Furthermore, it anecdotally seems as if talent is cross-pollinating between asset classes in ways it hasn’t before. Analysts and associates at mega-fund PE shops, who have little context for technology investing, are jumping to venture roles. Jim Breyer, formerly of Accel, joined Blackstone’s board in 2016.

Imperatives and Priors

The phenomenon of multi-asset players dipping their toes in venture actually isn’t new. Here’s an article from 2014 and one from 2011 that share a sentiment similar to mine from above. The questions I have are: Is this time different? If yes, why so?

There’s arguments to be made in both directions, and I don’t have a clear answer at this time. Some may believe this trend is cyclical, and hedge funds just look to private markets from time to time, perhaps even opportunistically on a company by company basis. Others could say the risk profiles of public markets investors and venture investors are fundamentally at odds with each other — incompatible. They can’t psychologically make the switch from one game to the other. Another theory is that the institutional imperative (to borrow from Buffett) prevents large funds from participating in the venture market and sticking around because this activity goes against the inherent nature or internal logic of the firm. And finally, some are just non-believers :)

However, this time could be different. There’s a world in which where large money players linger in the early-stage ecosystem, and traditional venture investors continue to move up market. If that becomes a structural condition, how do founders, employees, angels, seed investors, and the whole technology ecosystem respond? The hedge fund and private equity investors could shift their psychological makeup and risk appetite. LPs could mandate broader horizons in a world of ever-decreasing cost of capital. There are no easy answers, but I’m keeping my eyes on this state of affairs to see the shakeout.

Or, I could just say it’s a bubble and call it a day. 🤷🏽‍♂️

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