The future of Venture Capital is old folks

May 31, 2015
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Pensions are the right investors for VC. {focus_keyword} The future of Venture Capital is old folks bigstock Active Seniors Group Of Old F 41861599

Pensions are the right investors for VC.

VC +  pension funds = a great match

Traditional venture capital funds have a massive structural problem: their time horizons are far too short.  Pension funds do not suffer this problem.  The long time horizons of pension funds should give them a sustainable and demonstrable competitive advantage in the VC investing world: a VC fund with patience and liabilities measured on a 99 year time horizon should be able to crush the returns of funds with successive 7 year liquidity requirements.

Like most private equity funds (of which VC funds are a small subset), VC funds are traditionally structured with a 7 year time horizon.  After funds are raised from limited partners, they are invested over 2-3 years, the investments are held for 3-4 years and then the investments are liquidated over 2-3 years and proceeds are distributed back to the LPs.

This is the fatal structural flaw of most VC funds.  This is the reason investors have paid far too much in fees for far too weak returns. Fund managers are constantly fund-raising their next fund, and the time horizon for liquidity is far too short for them to back anything but the ‘flavour of the day’ hoping for a quick exit.  Almost invariably valuations will be high when the funds are raised (LPs only want to invest in VC when tech is a hot asset class); therefore valuations will be high when the funds are deployed, and thus it is almost axiomatic that fund returns will be weak.  This is precisely what happened to the true dogs of VC, the LSVCCs (labour-sponsored venture capital corporations) which were a tax-advantaged scheme all the rage around 2000, which paid obscene commissions to stock brokers and squandered RRSP savings.

The seven year cycle may be appropriate for leveraged buy-out funds.  It is nonsensical for venture capital.  You can take a big industrial company private and re-structure it in seven years, just as you can start and flip a science project in 7 years (eg. Instagram), but except in the rarest of cases you cannot start and build a good real business with real customers to maximum value in seven years. In fact, it is around year seven that good businesses normally start to accelerate and thus VC funds often need to sell just as the ROE is accelerating.  For instance, Kinaxis, which in 2014 was the last big Ottawa tech IPO prior to Shopify, has been around nearly 20 years and its growth is only accelerating now. However, its primary VC backer had to get out as part of the IPO and missed this growth spurt.

Canadian pension funds are just starting to play in the VC space, with OMERS Ventures, the VC arm of OMERS, the pension fund for Ontario municipal employees (including cops and firefighters) leading the way.  Already, OMERS Ventures has assembled a very impressive portfolio.  All of the hot Canadian companies are represented – Shopify, HootSuite, BuildDirect, Desire2Learn.  Of course, investing in good companies is just half the battle – getting the right price is crucial, but this is a very good looking portfolio.

The quality of the OMERS Venture portfolio probably illustrates the lack of competition in mezzanine VC (bigger investments, which follow seed) in Canada.  For now, it has the pick of the litter.  OMERS has big bucks, good management and patience.  Cops and firefighters in Ontario have crazy generous pensions.  Let’s hope OMERS Ventures does extremely well.

Neil