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Whether you like it or not, venture capital has become ever more widely available as an opportunity — albeit a risky one — for private investors.
Until just a few years ago, those who put their money to work in early-stage private businesses did so through tax-efficient venture capital trusts (VCTs) where they benefited from an immediate tax subsidy to help compensate for the higher risks implicit in these assets.
Venture capital has since worked its way into more mainstream investing via investment trusts. The most high-profile example is the venerable UK listed fund, Scottish Mortgage, which recently attracted attention after a boardroom bust up — much of it centred on that burgeoning private assets book of VC investments.
RIT Capital Partners, another venerable City institution, booked big profits in 2021 courtesy of its VC investments, but analysts at Investec recently pointed out that subsequent returns have been poor — while payments to the fund managers have been rather generous. That follows unflattering scrutiny of Jupiter’s Chrysalis Investments, which suffered huge losses when valuations crashed to earth in the wake of the pandemic.
These high-profile cases highlight a trend towards democratisation that has taken place as more experienced VC groups have listed their vehicles on the London market. These include not only Chrysalis Investments but also Molten Ventures (formerly Draper Esprit), Augmentum in the fintech space and Seraphim Space in, you guessed it, the space space.
Most of the attention on main market VC investments has been focused on issues of fees and liquidity — how quickly can you sell a position that has gone wrong?
But the real focus should be on how on earth do you value these private assets and businesses? In the table below I’ve listed the current discounts to stated net asset value for the main listed VC funds. As you will notice, the market is telling us something. If the fund managers value something at, say, £1, the market is saying it’s probably worth between 60p and 50p on that £1.
The main reason for this valuation conundrum is the funds are reporting historic numbers and the markets are discounting future haircuts as the funds’ valuation models react to a worsening in some sectors of private markets.
Let’s take Chrysalis Investments as an example. Its disclosure and timeliness of valuations have hugely improved in recent months. Back in summer 2021 one of its big investments, “buy now, pay later” fintech Klarna, was said to be worth $46bn. One year later that number was a much diminished $6.7bn.
As a result, Chrysalis has had to take out the marker pen on its own fund’s net asset value (NAV). In February, it reported a NAV of 128p, down from the last comparable number of 237p reported in February 2022.
Is that enough of a haircut? Trying to work out an alternative measurement is almost impossible but there are some useful guidelines. In the public markets, Cathie Wood’s Ark stable of ETFs invests in many of the early-stage tech businesses that would have been found in a typical VC portfolio just a few years ago. Her Innovation ETF, full of small-cap tech ex-wunderkinds, is down just under 60 per cent from the beginning of January 2022 (the start of the tech rout).
If these listed stocks in the Ark portfolio are down 60 per cent over that period (where we have decent visibility of the numbers because they are public), it’s not unreasonable to think that private, unlisted businesses — which are typically less established and riskier than their listed counterparts — face even bigger declines in value.
My hunch is that the late stage, pre-IPO businesses that feature heavily in, say, the Chrysalis portfolio are probably being marked down fairly accurately, although there may still be another 10 to 20 per cent to come off the headline numbers.
That makes me more cautiously optimistic about the Chrysalis position and share price — and I have started very slowly buying more stock. I rate Molten Ventures highly, as an all-round, all-stages VC, and it has made a decent start to revaluing its assets — although arguably there’s not been enough red ink in my view.
But that chunky discount is offering you some protection and Molten is also adamant that its focus on investing via preference shares — a share class that gives investors more power — better protects its position. Though maybe it doesn’t really matter what class of shares you have if the venture folds without value because it runs out of cash.
One other positive in my view is that the Ark Innovation ETF I mentioned has shown signs of life, rising 29 per cent in the year to date. I don’t think that’s any sign that all the tech sector pain is over, but it does show you that there are buyers out there who will bid up prices once valuations are realistic.
Another positive is that the European VC scene is still a long way behind its US counterpart. Once this cycle turns, there’s a decent chance — not certainty — that European VCs will have a strong rebound.
The bad news is that these early-stage investments move in long cycles. According to one academic studying the VC industry in the US in terms of deal flow, it took more than 17 years for investments in the (mainly US) venture market to recover from the 2000 crash.
One way of understanding how this cycle plays out is to look at the change in valuations of late stage, pre-IPO businesses versus early stage or even seed stage deals. I reckon the former is not too far off sensible numbers whereas the latter — the risky stuff — is still boasting slightly insane valuations. I see plenty of examples of ludicrous numbers being bandied about.
One other concern is that public market VCs might not have enough cash to make follow-on investments. In simple terms, if valuations are beginning to approach sane levels, arguably now is the time to start building up cash to deploy. By my count Chrysalis had only £69mn in cash before a recent top up to its Starling investment, while Molten has reported £28.5mn at PLC level in cash.
By contrast, a US-listed VC called Sutter Rock Capital, or Surocap, has $125mn on its balance sheet (versus a market cap of just over $100mn) in investable capital with a NAV that is at $7.39 a share versus a share price of around $3.60. In effect it is worth less in the market than its net cash — and today cash is very much king.
One last observation on Augmentum and Seraphim, both of which I like — just not at their current share price. These are very specialist funds, with Seraphim boasting a great portfolio of cutting edge space investments, while Augmentum has a fintech focus and a long record. Arguably the market is telling you that Augmentum’s portfolio is less risky than Seraphim’s — there’s a huge variation in discount rates of 20 per cent. My finger in the air guess is that the space sector might remain a bit unloved among mainstream investors for a while longer, which will weigh on Seraphim’s share price while fintech might come back into fashion rather sooner.
David Stevenson is an active private investor. He holds Scottish Mortgage, Molten Ventures and Chrysalis. Email: adventurous@ft.com. Twitter: @advinvestor.
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