“It is critical for investors to choose venture partners carefully. The returns generated by the best VC managers and the worst-performing is wider than the gap in other asset classes,” Lim said. “Furthermore, the number of VC firms has grown exponentially in the last decade.”
“It’s hard to really capture the number of VC funds, but they’re definitely in the thousands. And if you look at the types of venture funds, it’s staggering. You have pre-seed and seed funds, traditional early-stage funds, expansion-stage funds, growth equity funds and sector-only funds, and then you’ve got global funds,” Lim said. “For this reason, you see institutions partnering with firms like Greenspring to navigate fund manager and company co-investment opportunity identification and access.”
Even before selecting the appropriate partners, the first step for institutional investors considering a VC allocation is to determine both their risk appetite and liquidity profile.
“Venture capital should have a role in a portfolio, as long as your portfolio liquidity requirements support it,” Lim said.
Beyond that, institutional investors need to think about how to diversify a venture capital allocation. That diversification might reflect not only industry sectors, but vintage year, geography, stage, funds and co-investments on a primary and secondary basis.
“It’s often been said that like wine, there are good years and bad years in venture,” Lim said. “By being a long-term platform-oriented investor, you plant the seeds across various years and you can put yourself in a position to capture strong vintages. The last thing you want to do is try to market-time and pick one or two vintages.”
Once they’ve created a diversified venture capital allocation, institutional investors might consider further expanding their allocation by making co-investments, considering secondary funds or looking at very-early stage investments via seed/micro managers and ex-U.S.
Before making an allocation to venture capital, institutional investors need to have the staff to monitor the funds they’ve chosen or make sure that they have a reliable partner in the venture ecosystem who can do so on their behalf.
“It’s really, really hard with a thinly staffed team in venture capital to monitor these venture funds properly,” Lim said. “Venture managers raise funds every two to three years, so a limited partner will often have to re-up with a manager in three or four successive funds before knowing if the manager is good or not. This places a huge premium on an LP to figure out if the team and strategy is working, often with imperfect and ambiguous information.”
While venture capitalists have the luxury of not worrying about the typical gyrations of capital markets, Lim said that if interest rates were to rise, it could be good for the industry.
“If there’s a transition away from risk,” he said, “I do think that overall the reduced levels of venture capital raised will result in lower entry valuations and less hot money going into the category.”•