TPLC - The World Of Venture Capital Has Changed: Venture Capital Must Pivot

2023-03-30 11:22:51 ET

Summary

• Over the past ten years or so, the venture capital world has been awash with funds, even during times that might be considered to be "downtimes."
• It is becoming very apparent that the venture capital world benefited from the same "asset bubble" that many others benefited from during this time period.
• Now, it appears that this time period is over and the venture capital world must change, must alter its focus, and must choose investments in a different way.
• This "pivot" will not be an easy one and so venture capital funds must focus on what they can do, and what they can't do and re-focus their world.
• Being on the other side of an asset bubble is not an easy place to be.

Just one more narrative about the decline in the role that venture capital is playing in our current world.

Michael Casey, the founder of Portico Advisers, writes in the Financial Times :

"Venture capital blossomed from an artisanal strategy into a behemoth over the past decade, raising $163 billion last year in the U.S. alone."

Here again, I put the Federal Reserve right out there in front when we talk about the "financial bubbles" that blossomed for us in the 2010s and beyond.

The last decade, the last 15 years or so, were amazing to me. I had never seen anything like it when talking about the VC world...and the world of Angel finance.

Money seemed to be present all over the place.

And, the results in different sectors of the financial world were game-changing.

Stock Market Investing in the 2010s

When I read Mr. Casey's view of what took place over that period of time, I think back to other examples where investor behavior changed.

In the world of investing in the stock market, the quantitative easing brought about by Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, propelled stock prices to go up...and up...and up.

This was Mr. Bernanke's plan...and it worked.

But, investment behavior changed.

Value investing became less important because with stocks almost continuously rising, almost all stocks rose...and rose...and rose.

One could earn a very good return by investing in "market" portfolios, a return sufficiently high that efforts to build portfolios out of "value" stocks did not justify the effort.

Millions of dollars flowed out of value asset investing portfolio firms and flowed into investment operations that build their reputation by investing in "the market."

This movement, of course, contributed to the performance of "market-based" portfolios. And, these two factors worked together to define the era.

Venture Capital Investing in the 2010s

Venture capital investing changed in the 2010s.

Mr. Casey writes:

"The wall of cash in recent years led many VC funds to rely less on discrimination and judgment and more on playing a numbers game, investing in an array of start-ups in the hope that one delivered a vertiginous return."

"This has always been part of the VC playbook, but it became more gamified, descending into an undisciplined play on the momentum of industry and market trends."

"The standards of due diligence deteriorated."

Sounds kind of like what happened to investing in the stock market.

Moving Forward

The VC community cannot continue to invest in this way.

Things must change.

Things are changing.

One problem is, however, that many VC funds cannot re-orientate their focus that easily.

Venture capital funds, in the past, have usually developed specialties.

For example, Mr. Casey tells us that 39 percent of the industry indexed on "capital light" software and consumer start-ups in 2012.

This went up to 49 percent in 2021.

Now, this trend is being reversed.

And, the areas that are becoming more popular require new and deeper knowledge of the other fields.

For example:

"Many U.S. firms lack the expertise and networks to originate and evaluate deals in deep tech."

"They mostly do not have relationships with universities and technology transfer offices that can facilitate the commercialization of groundbreaking scientific discoveries."

"Not do they have the experience navigating labyrinthine regulatory pathways to bring novel technologies and therapies to market."

The World Has Moved

So, the Federal Reserve has changed.

The venture capital world has changed.

The venture capital industry is going to have to realize that it was working in a world generated by an asset bubble.

During that time, it prospered in a way that many other segments of the financial world prospered.

Now, it is facing the reality that the money is not there in the way it once was.

Like I said above, I couldn't believe how the venture world was functioning over the past decade or so.

And, many of my colleagues could not believe it either.

Now, the Federal Reserve is trying to shrink its balance sheet. We have quantitative tightening, rather than quantitative easing.

Now, the Federal Reserve is trying to keep interest rates rising. And, this is expected to go on for some time.

Rising rates and the collapse of Silicon Valley Bank have laid bare that reality.

As with other areas of the financial markets, many investors are still hoping that the Federal Reserve will pivot...will return to lower interest rates connected with lots and lots of money floating around.

Mr. Casey claims that

"These sentiments are delusional."

The world has changed.

The Federal Reserve has changed.

And, venture capital...and Angel finance...are going to have to change as well.

Things are not going to get easier.

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