“I wish I could say this is an isolated example,” Kirkland said, explaining the regulator’s concern about a small cohort of advisers who transfer client funds into high-risk investments after being referred by cold-calling telemarketers.
The industry has little chance of fighting through the legislative backlog and getting immediate wholesale change made to the ill-designed CSLR. There are things the government can do in the interim, said the FAAA, but who’s listening?
How late-stage VC provides ‘air cover’ through market cycles
Demand for venture capital (VC) has soared in recent years amidst expectations for more muted public-market returns. Late-stage VC sits between VC and traditional private equity (PE), and is focused on backing the rapidly growing segment of already-successful companies with established market share, and typically exhibiting $50 million or more in revenue.
“The number of publicly-traded companies has almost been cut in half, just looking at the US, while the number of private companies has surged,” says Christian Munafo, chief investment officer of late-stage VC investor Liberty Street Advisors. “One of the reasons is regulation and administration; it’s very expensive and burdensome for companies to get IPO-ready.
“The other part is there’s a lot of private companies with high growth rates focusing on optimising their business models for the long term, which can become challenging as a publicly-traded company, because they will be held to account to hit their quarterly earnings. This can expose them to a lot of unnecessary volatility.”
Munafo says a “massive amount of capital” is now being made available to those companies, meaning there’s no burning need to head to the public markets. In the 1990s, he says, the average tech company would look to go public just three to four years after its inception, and most of the value appreciation would happen as a public company. Now, companies are staying private for as long as 20 years, meaning that public market investors are “arguably missing out on a lot of growth,” he says.
There are already more than 900 VC-backed companies valued at more than US$1 billion as COVID-19 pulls innovation forward in a boom that has seen disruptive technology emerge across a range of sectors and industries.
“With late-stage venture, you have companies that have commercialized concepts into actual functioning businesses.” Munafo says. “You have real line items that you can monitor in terms of what their revenue looks like, gross margins, what the cost for these companies is to acquire customers, and how much revenue those customers yield in return, cash flow, profitability… how it performs over time.
“We’re looking for companies that have a certain level of revenue maturity so we can see if there’s predictability in the model, we can see if there’s a tendency for this company – through pattern recognition – to continue hitting its growth rates and its forecasts so it can grow into a much larger, more valuable business.”
And while venture capital isn’t entirely immune to legitimate macro changes happening in the background, it does “provide some air cover,” Munafo says, while its uncorrelated nature means it doesn’t have the exposure to “the idiosyncratic behavioural volatility” of the public markets.
“We obviously have geopolitical risk, we have inflationary risk in the United States and a rising rate environment, so I think in a protracted environment that can create a lot of pain,” Munafo says. “On the flipside, that creates a lot of opportunity.
“As an active investor we can take advantage of dislocations like this to build very interesting entry points for our clients and our portfolios, but we never like to see long-term, protracted periods of pain like this.”
Inflation also continues to rise, and will likely settle at levels that investors haven’t seen in a long time. The resulting increase in rates shouldn’t have a direct impact on growth companies as they don’t normally carry debt. While that might lead to a drop in appetite for new IPOs, VC investors typically see growth in other exit opportunities, like trade sales or M&A, as IPOs settle down.
“In the near-term, we don’t see inflation as a reason to move away from investing in late-stage venture capital,” Munafo says. “What inflation can do is create an environment where it’s harder for companies to get liquid, to pursue exits. It can pull back valuations, particularly for less differentiated companies.
“So it creates greater dispersion between high-quality and lesser-quality companies, pushes off some of the exit opportunities, and can create attractive risk-adjusted entry points,” he adds. “Investors certainly need to be more discerning, but we don’t think an inflationary environment is going to be a death knell for this industry.”
