IT CAN BE A DPRESSING EXPERIENCE talking to LPs about European venture, many of whom seem to have given up on the asset class. “For the last ten years, we’ve been told that it is too soon after the dotcom crash and that venture capital returns will improve. So far, we haven’t seen any evidence of that happening,” says Ralph Aerni, chief investment officer of SCM Strategy Capital Management.
In the last decade, European venture capital firms have made an average annual loss of 1.9 per cent, according to figures from EVCA. Institutional investors have been reluctant to throw good money after bad. SCM made its last allocation to European venture in 2001. “We haven’t seen any funds that would qualify for a commitment,” laments Aerni.
Outside the top decile of performers, returns have been disappointing. Surprisingly, given their reputation, the same is true of US funds, says Aerni: “We have seen some high-profile firms in the US who were impossible to access for new investors until the financial crisis. All I can say is that I’m glad we couldn’t access them before.”
Poor returns have led to industry navel-gazing. “Why do pharma companies outsource early-stage projects to venture-backed businesses? There must be a reason,” says Aerni. “They realise it isn’t a profitable business so they outsource the R&D and then buy the successful products. There are arguments that smaller companies can be more entrepreneurial, but I think that’s only half the story.”
Glimmers of hope
Doubters aside, there are some LPs that are still willing to bang the drum for the asset class. John Gripton, managing director of Capital Dynamics, points out that it’s impossible to determine a consistent pattern of returns in investment vehicles that lock up money for ten years. The mid-market may be the flavour of the month, but mega deals were attractive before the credit crunch. Distressed funds and secondaries, meanwhile, have been hyped for years. Even venture capital had its fleeting moment of glory before the dotcom crash. No one knows at which points of the cycle these assets will perform, so Gripton argues that it makes sense to have a balanced portfolio of allocations from early-stage venture to mega buyouts.
There are other reasons to be cheerful. It may be high-risk, but once in a while, VCs strike gold on a single asset. Simon Cook, chief executive of DFJ Esprit, says that in a typical year, the US venture industry returns between $40bn (€27.7bn) and $50bn a year from exits. Occasionally investors back a business with a market cap worth twice as much as the entire industry. By some estimates, Facebook is worth around $85bn. When Google listed in 2004, it was valued at $27bn. It’s now worth $185bn. “You never get a private equity exit that is worth twice the entire industry,” adds Cook.