With lenders slamming the door shut on easy and cheap debt for buyout firms, institutional investors are looking at venture capital to invest their private equity allocations.
But venture capitalists simply can’t handle all of the capital that investors would like to put in play. As a result, investors are expanding the definition of the subasset class to include everything from clean-tech investing to international venture capital funds.
“It’s still venture but a little bit adventure,” said Stephen Nesbitt, chief executive officer at alternative investment consultant Cliffwater LLC, Marina Del Rey, Calif.
For the year ended Sept. 30, the 200 largest U.S. pension funds increased their venture capital investments by 20% to $28.5 billion, according to Pensions & Investments.
Last year, venture capital firms raised $34.7 billion in 235 funds, the most capital they’ve raised since the $38.8 billion they attracted in 2001 in 318 funds, according to data from Thomson Financial, New York, and the National Venture Capital Association, Washington.
However, that’s still only one-sixth of the $209 billion that buyout funds raised last year.
“The problem is the amount of money raised by the very experienced venture capital groups is low and there are a lot of people (investors) who are shut out,” Mr. Nesbitt said.
Stronger recent performance also is luring investors.
“Returns are better. Venture capital seems to be turning around, improving,” said Monte Brem, chief executive officer at StepStone Group LLC, a private equity consulting firm in La Jolla, Calif.
The average venture capital return for the 12 months ended Sept. 30, the most current data available from Thomson and the venture capital association, was 32.3%, up from just 8.2% for the preceding 12-month period.
Push into clean tech
But it is not venture capital investing as usual. Institutional investors are investing in new types of investments including clean technology, emerging venture, international venture and venture lending.
Institutional investors also are investing in more late-stage venture capital, rather than the early stage that was most popular before the tech bubble burst. They are investing with firms that are straying from venture’s traditional technology focus to move into consumer-oriented and other non-technology-related businesses.
Much of the growth in the number of companies backed by venture capital firms was in the clean-technology sector. In 2007, clean-tech investment grew to $5.18 billion, up from $3.6 billion the year before. Clean-tech investments in North America jumped 38% to $3.95 billion; European clean-tech investments rose 34% to $1.23 billion, according to the Cleantech Group, an Ann Arbor, Mich.-based industry trade group.
For instance, Silicon Valley venture capital powerhouse Kleiner Perkins Caulfield & Byers devoted some $200 million of its last $500 million fund to clean technology. Yale University’s $18 billion endowment fund and University of California’s $57 billion pension fund are investors.
In November, Kleiner Perkins joined with London-based Generation Investment Management LLP — founded by former U.S. Vice President Al Gore and former Goldman Sachs Asset Management CEO David Blood — to make global green investments. Mr. Gore is now also a Kleiner Perkins partner. The $174 billion California State Teachers’ Retirement System, Sacramento, is an investor with Generation Investment Management.
Another traditional venture capital firm — Draper Fisher Jurvetson, Menlo Park, Calif. — is also active in the clean-tech sector, investing in 12 deals amounting to more than $80 million and through a related venture capital firm DFJ Element, also in Menlo Park. (DFJ Element is a joint venture of Element Venture Partners, Radnor, Pa and Draper Fisher Jurvetson.)
Venture capital firm Rockport Capital Partners, Boston, also is active in clean technology. Other venture firms investing almost entirely in the clean-tech sector include Nth Power LLC, San Francisco, and Technology Partners, Palo Alto, Calif., which last year closed a $300 million clean technology and life science sector venture capital fund, raising $50 million more than its target. Indiana Public Employees’ Retirement Fund, Indianapolis, and the San Francisco City and County Employees’ Retirement System are investors in the new fund.
In January, Morgan Stanley bought a minority stake in clean-technology venture capital firm, NGEN Partners. The $174 billion California State Teachers’ Retirement System, Sacramento, is a NGEN Partners investor.
Kleiner Perkins also has launched operations in China. Last year, firm officials opened offices in Beijing and Shanghai.
New Enterprise Associates, Chevy Chase, Md., has operations in India and China. It is also a limited partner along with Graylock Partners, San Mateo, Calif., in the $350 million Northern Light Venture Capital Fund II, which invests in venture capital in China.
Still, venture capital around the globe is a work in progress.
“Europe is a disappointment in terms of returns and venture capital in Asia is pretty small relative to the capital institutions want to deploy into the market,” Cliffwater’s Mr. Nesbitt said.
Lines blurring
But institutional investors are taking different approaches.
“Investors are moving to different ways of investing, to non-traditional venture capital. Things that are a little bit different,” Mr. Nesbitt said.
For example, the $246 billion California Public Employees’ Retirement System, Sacramento, has formed a joint venture with Oak Hill Investment Management, Menlo Park, Calif., in which they will bundle different types of venture capital or smaller buyout investments. CalPERS also created a series of venture capital separate accounts in clean tech and emerging markets.
Investors are also blurring the line between venture capital and buyouts within their venture capital portfolios.
“For venture capital, we’ve spent a lot of time looking at later-stage venture, expansion and growth in technology, and also small buyout,” said Clark McKinley, CalPERS spokesman. “We’ve found some opportunities in expansion and growth and small tech buyout, rather than late-stage venture.”
Some institutions are starting to invest in young venture capital firms. For example the largest venture capital fund now on the road is Lachman & Malik Capital’s $5 billion Fiber-to-the-Home Revolution Fund, according to data from Private Equity Intelligence Ltd., London.
This expanding definition of venture capital might not be enough to accommodate demand. Larger institutional investors with $2 billion to $4 billion a year to commit are shifting some of their allocations to various forms of private equity such as small and midsize buyouts distressed and international buyouts, Mr. Brem said.
“There’s a lot of demand for venture capital. If you are a good venture capital firm and have good returns, there is more demand than you know what to do with,” he said.
