REDWOOD CITY, Calif. — Even as Wall Street trembles, the market for investing in tech start-ups remains white-hot. Still, some investors are proceeding with extreme caution.
Saying they learned their lesson in the dot-com boom and bust, and the 2008 recession, the institutional investors — pension funds, university endowments and foundations — that put money in venture capital funds are more selectively choosing the firms in which they invest, doing exhaustive research before handing over money, and in some cases driving hard bargains for more favorable management fees and shares of profits.
Though most say they remain bullish on venture capital, they know that as the limited partners, they would be the ones to feel the pain if a bubble bursts. After all, they put up most of the money.
And as they watch the stock market gyrate, they remember all too clearly the nightmarish consequences of having too much of their money tied up in illiquid assets like venture capital in late 2008 and 2009. They have recently slowed their investing in venture funds and could cut back more.
“Whenever there’s market tumult, people get more nervous about how illiquid and long-dated their portfolios are,” said Chris Douvos, co-head of private equity at the Investment Fund for Foundations. “My worry is if you have continued tumult, it’s going to scare people away.”
Even before last week, the days when institutional investors threw money at venture funds because they felt lucky just to be able to invest were gone. More recently, they want more transparency from the famously tight-lipped funds, and in some cases, they are getting it. One firm has started giving limited partners files with its portfolio companies’ financial information, a rarity. And limited partners say venture capitalists are increasingly available for one-on-one meetings.
“I call it the Madoff effect,” said Jordan Silber, a partner in the venture capital group at the law firm Cooley, speaking recently at the Venture Capital Investing Conference here in Redwood City, outside of San Francisco. “We’re seeing extremely deep dives and due diligence and looking at people and their track record in a way we’ve just never seen before.”
Despite the fervor over companies that have gone public or are on the verge of doing so, like LinkedIn, Facebook and Groupon, and even though venture capitalists are investing more money in start-ups than they have for the last two years, institutional investment in venture capital funds is near the five-year quarterly low.
Limited partners invested $2.7 billion in 37 funds in the second quarter, half of which went to a single firm, Accel, an investor in Facebook and Groupon. Investment was down from $7.6 billion in 42 funds in the first quarter, according to the National Venture Capital Association, though it was up 28 percent from the same period last year.
Limited partners say they are wary because venture capitalists are investing in start-ups at valuations several times higher than a year ago.
“I look at some of the companies and they really don’t have a business model, so I’m afraid,” said Kelvin Liu, a director at Invesco Private Capital, at the conference, which was hosted by International Business Forum. “To people who are willing to pay at $5 or $10 billion valuations, I say: ‘Why are you doing that? Take your money out.’ ”
Venture capital attracts universities in particular, which have followed the so-called Yale model by investing in alternative, illiquid assets. But universities and other institutional investors froze in late 2008. Suddenly faced with shrinking investments in public equities, many, including Duke, Columbia and Harvard, sold or considered selling their stakes in illiquid venture funds on the secondary market or sharply decreased the amount they invested in venture.
Now, just as limited partners are tiptoeing back to the asset class, talk of a another stock market crash as well as of a tech bubble is making them skittish, even as they say they remain long-term investors and are heartened by recent initial public offerings.
“We are absolutely positive, and it’s been a great exit environment over the last six months,” said Nicole Belytschko, who leads venture capital investing at C.M. Capital. “But at the same time, while we’re getting a lot of capital back from very good exits, our managers are deploying capital at very expensive valuations.”
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