As the number of companies delaying their public debuts rises, so too does the number of ‘unicorns’ – with that number leaping from 4 in 2011 to 728 today. This has caused a splash across the market, both private and public. For family offices exploring new asset classes, late-stage venture might be worth considering.
What is a late-stage venture?
While there is no textbook definition of what a late-stage venture is, the term generally refers to a startup that is scaling up its operations. This is often why they are called scale-ups to distinguish them from early-stage ventures.
In industry parlance, late-stage ventures are startups that have found product-market-fit and are now investing in sales and support functions to drive revenue growth.
This phase is the longest in a startup’s lifecycle and – at the risk of being prescriptive – tends to start after the critical Series A financing round. During this time, the business is likely to launch new products, enter new markets and geographies, professionalize its operations and strengthen its management team.
Historically, these companies would have looked to IPO within a few years of starting their scaling journey, however “going public” has become increasingly unattractive due to a variety of factors. Firstly, there are the general frictions of being a public company. The distraction of quarterly reporting, greater public scrutiny and the regulatory compliance burden that comes with listing securities on an exchange, which inevitably reduce management’s bandwidth to focus on growing the business. Secondly, founders looking for high degrees of control and autonomy will find public markets are less tolerable than private boardrooms (albeit more so than they were a decade ago). Thirdly, the IPO process is opaque and expensive. Valuations and allocations are influenced by bankers who favour their most-profitable clients and are compensated with a percentage of the capital raised (and not necessarily on the value-add of their services).
Usually, a company would have to accept these inconveniences as the price to pay for the liquidity and publicity of being a publicly-traded company. But things have changed. Firstly, recent innovations such as direct listings and special-purpose acquisition company (SPAC) mergers, now provide liquidity to founders without many of the drawbacks of a traditional IPO. But more importantly, many hedge funds and mutual funds have decided to skip the mayhem of the IPO and invest in the primary financing rounds of private companies to participate in the value creation that happens before companies are offered to the public. Indeed, no group of investors has had a bigger impact on the world of VC than the “tiger cubs”, a group of hedge funds run by former employees of Tiger Management – principally, Tiger Global Management, Coatue Management and Dragoneer Investment Management.
And while the tiger cubs have started to hunt unicorns, successful early-stage funds (such as Accel and A16Z, to name a few.) have leveraged their cap table positions to raise and deploy more capital at later stages. Sequoia’s recent shakeup of its fund structure is just another step in this evolution as they have realised that they are as good custodians of capital in public markets as they are in private ones (and are happy to be paid to do both).
But if we step back for a moment, it’s clear that a virtuous cycle has developed. High-growth startups wanting to stay private for longer has unleashed a rush of capital into private markets which have boosted valuations in late-stage venture rounds, making them more attractive to founders and boosting returns, which in turn has drawn more capital to the space. And it’s difficult to see anything that will bring the IPO back in vogue. In the hyper-informed world that we live in today, the publicity benefit of being a public company is not what it used to be and even the liquidity advantage is being reduced daily by the development of informal secondary markets and trading platforms for private company stock.
Why should family offices consider investing in late-stage ventures?
As we like to say around here, it’s simple: late-stage venture offers the high return potential of venture capital with less risk (as measured by return volatility) and more liquidity. It’s also an area where the investment manager, whether in-house or external, has the greatest scope to generate supernormal returns through skill. In early-stage venture capital, the large variation in investment outcomes and fund returns makes it extremely difficult to differentiate between luck and the skills of the investor while public markets no longer offer sufficient mispricings and special situations for professional investors to consistently generate attributable outperformance. Yet most family offices have not invested in late-stage ventures as they do not have access to late-stage primary financing rounds. Led by the right people who help them to invest in compelling late-stage startups, family offices can actively manage their exposure to the most attractive risk/return profiles in private markets today.