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Investing in Venture Capital - Limited Partner or Fund of Funds? - Part 1

Igor Sill, Managing Director of Geneva Venture Management LLC


Investor confidence in Venture Capital is at an all time high. The unusually strong Initial Public Offering (IPO) market and its pent up pipeline is due in part over the tremendous success of Venture Capital funded Linkedin's recent public market debut. LinkedIn shares skyrocketed to a high of $92.99 per share from its opening of $45., establishing a market value of $8.9 Billion, virtually overnight. Other high valued IPO candidates include Facebook, Twitter, Groupon, Zygna, to name but just a few. The markets have reinvigorated investor confidence in venture backed companies back to the levels of 2004 when the biggest Internet IPO, Google, followed by Salesforce.com, debuted. This strong IPO pipeline in conjunction with Microsoft's acquisition of SKYPE for $8.5 Billion represents a significant liquidity window for Venture Capitalists and their Limited Partner investors. Though Venture returns have been relatively meager over the past 5 years, Venture Capitalists have been busy re-focusing their firms while continuing to invest and develop their existing portfolios. The timing now seems optimal for realizing liquidity and impressive venture returns.

A global revolution is changing the way serious alternative asset class investors view the venture capital industry. Discarding the old rules, a new, younger era of Venture Capital Fund Managers is re-inventing the venture capital industry. The traditional seed and early stage Venture Capital investing model has changed radically and Institutional Investors are seriously re-assessing the allocation method they once used for this asset class. Many are seizing the benefits of higher returns coupled with lower investment risk by utilizing the breadth and depth of expertise, knowledge and resources that an experienced Fund of Funds (FoFs) firm provides.

Simply stated, a FoFs is a multi-manager investment strategy of holding a portfolio of other investment funds rather than investing directly in private equity, shares, bonds, or other securities.

There are different types of 'Fund of Funds', each investing in a different type of collective investment sectors, such as Hedge Fund FoFs, Mutual Fund FoFs, Investment Trust FoFs, Real Estate Trust FoFs, and for the purposes intended here, Venture Capital and Private Equity FoFs. Venture capital investments are, by their very nature, a long term higher risk, illiquid asset class. Its historical returns, however, have out-performed other investment types. Via a Limited Partnership (LP) arrangement, an investor is typically committing funds in the $500,000 upwards to $10 million range for 10 plus years. Redemption liquidity via after market (secondary) sales are limited and generally require prior approval by the fund's General Partner (GP), thus are generally considered illiquid during the fund's term. This suggests that venture capital fund investments are better suited for investors with much longer investment time horizons such as Foundations, Pension funds, Family Investment Offices and Endowments.

The very best Venture funds have consistently out-performed the industry and, of course, it's everyone's ambition to invest in the top quartile of these funds. After all, some of the most successful public Corporations such as Apple, Amazon, AOL, Baidu, BusinessObjects (SAP), Cisco, Compaq (HP), eBay, Genentech, Google, Hewlett-Packard, HomeDepot, Informix (IBM), Intel, Linkedin, Microsoft, Netscape, NetSuite, Oracle, Salesforce.com, Skype (Microsoft), Starbucks, Sun Microsystems (Oracle), PayPal (eBay), Yahoo, YouTube (Google) and, privately-held Facebook were all financed by Silicon Valley venture capital funds. The LP investors in these funds realized significant healthy returns while Facebook's investors continue to realize tremendous value appreciation.

David Swensen, the visionary chief investment officer at Yale University, has also realized great investment success in the alternative asset classes. When he arrived at Yale in 1985, its endowment was worth approximately $1 billion, and today the endowment is worth nearly $17 billion. Swensen increased investments in private equity funds, venture capital, real estate and hedge funds, an investment strategy that was met with some initial skepticism.

Swensen is a big believer in asset allocation and rebalancing. "Asset allocation is the tool that you use to determine the risk and return characteristics of your portfolio. It's overwhelmingly important in terms of the results you achieve." In numerous speeches, Swensen has championed such alternative investments. He argues that while beating the stock market is almost impossible due to the overwhelming available information about public companies and the subsequent valuation, astute managers can exploit inefficiencies in the value pricing of less familiar private assets. Diversification into alternatives, he added, reduces risk. He argues that keeping funds in investments that are more liquid is a tactic of short-term players versus that of endowments, which tend to hold until private equities are sold or go public. Swensen says "Investors should pursue success, not liquidity. Portfolio managers should fear failure, not illiquidity. Accepting illiquidity pays outsized dividends to the patient long-term investor." Over the past 20 years, no educational institution has achieved a better performance record than Yale.

Institutional investors are rightfully concerned with fulfilling their fiduciary duties by selecting specific venture funds and Fund Managers with focused market segment expertise.

Understanding which market sectors are most likely to outperform, coupled with identifying capable Fund Managers to exploit those opportunities are a critical component of the investor's decision making process.

Continued on 7/14/2011 ...


Igor M. Sill, Managing Director, igor@genevavc.com

The author, Igor Sill, is a Silicon Valley venture capitalist and founder of Geneva Venture Partners. He is a Limited Partner in Goldman Sachs Investment Partners, Benchmark Capital, Norwest Ventures, Brentwood Associates, SV Angels, ICO Funds, The Endowment Fund and Granite Ventures. Sill was educated at the University of California, Berkeley, received his MBA from the Said Business School, University of Oxford and is a member of Merton College, Oxford University. He also attended Harvard Business School's Venture Capital Program, Stanford Graduate School of Business Advanced Management College and Stanford Law School Directors College. He is a Fund Advisor to 7Capital and Red Herring Limited and has managed venture investments on behalf of Societe Generale, AXA, Thales Group, Ace Management, Venture Capital Funds and numerous Family offices. Special thanks to David Swensen of Yale University, Cain Soltoff, Yale Investment Office, Legendary Venture Capitalist: Bill Draper, Paul Rydberg of Goldman Sachs Private Wealth Management Group, Emmanuel Roubinowitz of Fondinvest Capital and Dr. Mark Cannice, Professor of Entrepreneurship & Innovation at University of San Francisco Graduate School of Management for their sound advice and contributions to this article.