One of the hallmarks of financial bubbles is dumb money pouring into unfamiliar places. The latest, in some ways strangest example is the current stampede of non-tech investors into the trickiest part of the tech market: Silicon Valley startups. From today’s Wall Street Journal:
Hedge, mutual and pension funds are investing heavily, leading to higher valuations and more leverage for company founders
The world’s largest investment funds are descending on Silicon Valley with unprecedented financial force, roiling the once-niche business of technology startup funding and crowding out traditional venture capitalists.
Hedge funds, mutual funds, pensions, sovereign-wealth groups and other financial institutions known as nontraditional investors in Silicon Valley have become the powertrain behind record-setting funding rounds and valuations. They were more active in the second quarter than in any previous period, participating in 42% of startup financing deals, and those deals accounted for more than three-quarters of all the invested capital, according to research firm PitchBook Data Inc.
These financial institutions have propelled a historic rally in startup financing. Investment in U.S. startups for the first half of the year hit $150 billion, eclipsing full-year funding every year before 2020 and on pace to nearly double last year’s record, according to a report from PitchBook.
The large asset firms have massive pools of capital, move quickly and are less likely to ask for board seats or involvement in company decisions, often making them more appealing to founders, according to interviews with investors and startup executives. The result has been a dizzying pace of deal making.
“It’s like speed dating but more extreme,” said Peter Fishman, a longtime Silicon Valley tech professional who last year co-founded data-automation startup Mozart Data Inc.
Big money managers have long allocated some of their portfolios to invest in traditional venture-capital firms. But many started investing directly in startups around a decade ago in a near-zero interest-rate economy and after a decline in the number of publicly traded companies that started after the dot-com era, looking for better returns from tech companies that were staying private longer. Over the years, traditional venture capitalists often panned them as tourist investors and dumb money who lacked the particular skill set for startup investing.
But they stuck around and doubled down. Today, among the top 10 investors in startups by dollar amount, half are nontraditional venture investors, including Fidelity Investments Inc. and Tiger Global Management. The number of startup funding rounds that include only nontraditional VC investors and zero venture-capital firms has doubled over the past 10 years, according to PitchBook.
U.K.-based asset management firm Baillie Gifford, which has more than $450 billion under management, made its first startup investment in 2012, and in 2019 launched a dedicated private-market portfolio “to really start pouring serious amounts of capital into the late-stage private markets,” portfolio manager Robert Natzler said.
Some traditional venture firms are scrapping old practices to keep pace. To move quickly, some venture capitalists said they are cutting back on audits and customer checks, and taking a startup’s word on profit and loss.
“There are no VC funds with pricing discipline. All of us have caved,” venture capitalist Keith Rabois tweeted last month.
From 2016 through 2019, there were on average 35 deals a month with funding rounds that reached $100 million or more, according to data provider CB Insights. This year, it is 126 deals a month.
All that money has sent valuations soaring, which boosts profits on paper for all types of startup investors and their founders. Five years ago, 14 startups attained valuations of $1 billion or more during the April through June quarter, according to CB Insights. This year, 136 companies achieved that valuation during the three-month period.
Non-traditional dumb money
Wall Street investment companies aren’t normally characterized as dumb money. But when it comes to tech startups they are novices with big checkbooks, the combination that inspired the “fool and his money” aphorism.
Put another way, hedge funds and pension funds are used to owning and/or trading liquid assets. In the next crash (coming as soon as valuations start to matter again), they’ll learn the meaning of “illiquid”.