The massive losses in the stock market in March, which is closing the week deeply in bear market territory after a historic 11-year bull, likely mean venture investing will slow for a few quarters as portfolio managers shore up existing companies and the wealthy investors who make up the limited partners in the funds tread cautiously. But limited partners seeking an alternative to the public markets could boost the asset class as a whole after that, based on what happened after the financial crisis of 2008-09.
“In 2001 and 2008 that’s exactly what you saw, all investments went down and VCs took a particularly hard hit. People want to make sure the ground is level before they return to investing,” said James Rowe, principal of Boulder City, Nevada-based Rowe Capital Partners, that works with 1,100 family offices globally along with institutional investors in raising assets for direct investments and other alternative investments.
The key questions facing the venture investment world now are how long the slowdown lasts — a couple of quarters seems to be the emerging consensus — and which portfolio managers are in a position to invest in promising companies as valuations decline. Impact investing may also gain more traction as limited partners and portfolio managers seek to invest in companies with solutions for health care or public health infrastructure.
“In the next three months, there will be some impact certainly,” said Shelly Porges, co-founder and managing partner of venture capital firms, Beyond the Billion and The Billion Dollar Fund for Women. “But in the medium and long term, there should be little negative impact. Capital can only sit on the sidelines so long before it becomes a drag on a fund’s overall performance.”
Can We See The Future Through The Lens Of The Financial Crisis?
Many people are looking to the rebound after the global financial crisis for clues. But the global financial crisis was an extreme event based in financial markets — which had years of work to do as assets were repriced and confidence had to be rebuilt. Much is yet unknown about the effects of the coronavirus and how long economic activity will be tamped down. And one of the emerging characteristics of the algorithmic trading that is now dominating markets is that financial markets are less tied to what happens in the real economy.
After the financial crisis, venture capital fell to $271 billion in December 2008, according to data from Preqin, a company that tracks alternative asset data. Even by the first quarter of 2009, funding dipped by 50% to $3.9 billion from the previous year. The investment amount marked the lowest amount since 1998, according to a report from Dow Jones VentureSource.
“A look back at the history of public market performance alongside the VC space indicates that in all but the most severe downturn in the public space, the VC market just churns on,” said Howard Lubert, co-founder of Keiretsu Forum Mid-Atlantic and South-East, a private group for accredited angel investors.
A few years after the global financial crisis, investors had flooded into private equity asset classes of all kinds. Private equity devotees tout the returns – based on the past 25 years that ended in March 2019, their funds generated returns of 13% annualized, higher than the 9% return for the same investment in the S&P 500, based on the index that Cambridge Associates, an investment firm, founded.
Investor appetite for VC-backed deals returned and the industry had $524 billion worth of assets by June 2016, which is almost double the $271 billion at the end of December 2008, Preqin said. In 2019, the value of venture capital deals for US-based companies rose to a new record of $109 billion.
That track record, combined with the new appetite for innovation that could arise after the public health crisis of the coronavirus, is leading to optimism about the long-term future.
The appetite for the industry could rise, said Paul O’Brien, CEO of MediaTech Ventures, an Austin-based venture development group that works in economic development and capital for media, including video games, podcasting and news.
“We might see a resurgence in the importance and role that venture capital plays,” he said.
The industry is known for taking risks and the global economy “needs this more than ever,” O’Brien said. “VCs can leverage capital to provide solutions to circumstances like we are going through now. Venture capital will play an even larger role in the biotech and healthcare industries.”
Venture capital firms will be looking to new innovations sparked by the impact of the virus. Developing vaccines, new testing options, supply chain improvements, medical devices plus B2B technology to facilitate virtual meetings plus work at home tools are on the horizon. “Many industries are already adapting and coping and will see the same thing with startups,” said Judy Robinett, board member of several venture capital firms and an advisor in angel groups who also speaks and writes about the industry. “If you have a good story someone out there will listen to you. There will be interesting innovation.”
Another unknown is the extent to which impact investing will affect the timing and characteristics of the recovery. Investors who pull back for a few months to survey the landscape may come back with a more thoughtful strategy.
While there will be temporary setbacks, the venture capital industry will instead face some “right-sizing” and seek opportunities on innovative tech-enabled companies that address some of the new health, communications and transportation challenges, said Porges.
Capital Will Return
Limited partner investors in venture funds such as foundations and endowments are already long-term investors, Porges said. They will continue to invest in top-tier funds, but the question is whether they will do a better job of fulfilling their emerging manager mandates.
“Any investor in alternatives knows they’re going to be waiting,” she said.
The good news is that investments made in 2004 to 2008 after the tech bust in 2000, especially in early stage startups, exceeded the performance of other alternative assets such as private equity and real estate, Porges said.
The valuations of companies and the terms of deals are likely to decline in the aftermath of a crisis, which can be an advantage for venture partners.
“Investors see this as an opportunity and keep their powder dry for these opportunities,” Porges said.