Hedge funds storm into venture: VCJ cover story

You may disagree on whether Dropbox is worth an estimated $9.6 billion, Pinterest, $3.8 billion, or Uber, $3.5 billion.
But you will agree on this: All are rich valuations and a surge of pre-IPO money is fueling them to extraordinary heights.

One source of that money is hedge and mutual funds, where deal activity has soared this year.

What these non-traditional investors – Tiger Global Management, Coatue Management, TPG Capital, Fidelity Investments and T. Rowe Price – want is an inside track to IPOs and access to growth companies they can’t find in the public markets. What they have helped create is a spike in mega rounds and valuations, trends with potentially threatening consequences.

“This is momentum investing,” said Tim Guleri, managing director at Sierra Ventures. “Overall, too much of this is a dangerous trend.”

The danger will mount with any change in the IPO window, or if public valuations fail to recover from their March selloff. Either could place private company valuations under pressure and chip away at the market value of portfolios priced off them.

It will be an issue of special importance to VCs over the coming months. After years of being the forgotten asset class, venture has come bounding back with rising returns, improved fundraising and promising portfolio exits. Overfunding a generation of portfolio companies could undermine some of these gains just as the limited partner perception of the industry is beginning to change.

Already some venture investors have begun to show caution and back away from late-stage financings because of the high level of competition.

Anytime there is a bull market, outside money wants to get into late stage financings, said Jules Maltz, general partner at Institutional Venture Partners. “That works as long as the market continues. As soon as the market changes, we often see these funds pull back.”

Whether these funds will retreat is hard to gauge. So far, there are mixed signals. Tiger’s ability to close on a new $1.5 billion venture fund in April suggests access to capital is not likely a restraint. However, Coatue in March said it planned to return $2 billion to investors, suggesting second thoughts are creeping in.

Up to now, it is hard to miss the heightened role hedge and mutual funds have played this year. Through mid-April, they have participated in 23 deals this year with U.S.-based startups, including large rounds for Dropbox, Cloudera, Lyft and Intarcia Therapeutics, according to data from Thomson Reuters (publisher of peHUB and VCJ) and other industry sources.

f this pace continues, the year could end with 75 to 80 deals outsized deals involving a hedge or mutual, a substantial increase from last year’s 41.

Equally significant is the massive size of the transactions. Hedge and mutual funds have participated in 14, or 60 percent, of this year’s largest two-dozen U.S.-based deals with disclosed investors, compared to about 38 percent last year.

“You are seeing some willingness to write large checks for select companies with a winner take all paradigm,” said Timothy Keating, CEO of Keating Capital. “I do believe you are seeing some inflation in those highly publicized companies.”

This story first appeared in Reuters Venture Capital Journal. Subscribers can read the original story here. For a related article called “Valuation discipline remains, mutual fund investors say,” subscribers can go here. To subscribe to VCJ, please email [email protected].

Photo illustration by Janet Yuen for Venture Capital Journal.