By Thomas J. Raymond Jr., CFA

Why venture capital? There is a broad mystique when it comes to the venture capital space. It’s a part of the private markets that gave rise to the likes of Uber, payment software company Stripe, and Netflix. It’s where capital and disruptive ideas come together to bring new companies to the mainstream, and in doing so create the prospect of performance exceeding that of the public markets. Yet, this intrigue and excitement can also mask a number of risks not readily apparent.

Consider the story of Adam Neumann, a captivating showman with an infectious energy. His traits paved the way for the meteoric rise of his company WeWork, being that his persuasive personality convinced investors far and wide of the company’s vision. He was one of those rare talents that could take a company to rarefied levels, and he did. But WeWork’s fall was similarly spectacular. The rise and fall of WeWork is a cautionary tale that good ideas also need good implementation, along with the high-risk nature associated with the venture capital space. There is plenty of value created in this corner of the private markets, but execution is critical.

Venture capital is a space hard to ignore, as the technology it has brought to life affects the world around us in various ways. But investors need to approach it in a systematic, diversified way, as it is a risky asset class. It’s also competitive. Notably, more than $6 trillion in cash sits on corporate balance sheets, which is a currency to acquire innovation. Many companies will have an eye on venture-backed businesses, which has various investment implications. They are also not the only ones exploring this opportunity set.

Public funds – There have been some tectonic shifts in the public and private markets. With much more capital available in the private markets – coupled with fewer demands and less scrutiny of that market compared with those publicly traded – companies are less reliant on the public markets now. As of 2018, the median age of venture-capital-backed technology companies at the time of their IPO increased to 10.9 years, up from 7.9 years in 2006.¹ This meant an increasing amount of value creation was occurring within the private markets, which prompted a response from an unlikely space - the mutual fund complex. By 2015, they had invested $8 billion in venture-backed private (i.e., not daily traded) companies. This compares to $16 million two decades prior.² It’s a double-edged sword for public funds moonlighting as venture capital investors. It opens the door to more opportunities for these funds and also for a broader number of people to invest in them, but by managers that may not have the requisite experience. Indeed, the lines between public and private markets are increasingly blurred.

Innovation era – The pandemic altered public policy, daily habits, and business decision-making in possibly permanent ways. Themes such as remote work, telehealth, and digital payments have all been super-charged by the events of past 18 months. It’s also prompted many companies to remake themselves: banks are endeavoring to be fintech companies and media giants want to be Netflix. There is another entity getting into the innovation game: government. It, too, wants to redefine the future, and it is spending a considerable sum to do so. Over the next decade, $55 billion will be devoted to water infrastructure, $65 billion to broadband, and another $21 billion for environmental remediation.³ This has the feel of a private equity fund that has committed capital, but with money yet to be deployed. Broadly speaking, corporations and government will be financing, backstopping, and acquiring innovation, and by extension the venture capital companies that deliver it.

The future is coming faster than ever, but that doesn’t mean every idea will be part of the final equation. Prudent investing in venture capital requires a recognition that failures will happen as vision and ideas need to be matched with execution and sound governance. Diversification, patience, and humility can lessen the risk, as can having the right vehicle and manager in place that recognizes this. There will be plenty of disruptive ideas that become the next Uber or Netflix with many on the hunt for them. But there will also be plenty that don’t. Knowing both of these realities is key to navigating this era of innovation.

¹ Franklin Templeton, May 24, 2019
² “The Cult of We,” Brown and Farrell (2021)
³ U.S. Senate, White House, Moody’s Analytics

Thomas J. Raymond Jr., CFA, is a senior portfolio manager for a multifamily office in Philadelphia. He can be reached at traymondjr@gmail.com.

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