The Venture Wreckage

Let's Talk About the Venture Wreckage

One of this week's news stories comes from the UK. Molten Ventures, a listed VC fund, reported its finances shortly after reducing the valuation of Revolut, a portfolio company, by 40%. Molten is trading at £2.79 a share with a net asset value of £7.80 a share. A discount of 65%. Molten is a good investor and plays a strategic role in the UK and European ecosystem; It was previously known as Draper Espirit. So where is its focus?

Group chief executive, Martin Davis, confirmed that "cash preservation and balance sheet management" are the main priorities while markets remain subdued, although perhaps the main long-term challenge facing management is the general reduction in market liquidity.

Cash preservation, balance sheet management in the short term, and liquidity long term.

This is a pretty decent appraisal of the state of venture capital globally. The asset class has a few fundamental challenges. Some are short-term, and others are structural.

The investments made between 2020 and 2022 are almost entirely over-priced in today's market. 2023 deals are being done at more realistic valuations.

Overpriced deals translate into a slowdown in subsequent funding rounds as companies preserve cash in order to avoid raising. So valuations stall at unrealistically high prices.

Fund managers do not draw down as much if any, capital from their LPs.

LPs cannot fund new funds as aggressively due to locked-up earlier funds not being liquid.

Growth investors have all but disappeared from the market, making mid-stage investments harder, as the future value cannot be assessed.

New managers cannot raise funds as easily.

Opportunity Funds are no longer a good idea as opportunities to invest in winners dry up.

New startups, not impacted by the 2020-2022 market, attract seed funds more easily, although at realistic valuations.

There are many other symptoms of the hangover from those three years. Suffice it to say that there is a new focus on actual cash returns from funds to their investors. IRR, MOIC, and TVPI are mocked. Only DPI is considered real. For the uninitiated:

IRR - Internal Rate of Return - measures the annualized paper gains made by investors, with time as a major variable.

MOIC - Multiple on Invested capital - measures the paper gains of investments based on dividing the current value of an asset by its starting value at the investment.

TVPI - Total Value to Paid In Capital - measures the real plus paper gains compared to all capital drawn down from investors. Most TVPI is paper-gain heavy.

DPI - Distributions to Paid In Capital - measures actual cash returned to investors compared to the amount they have given to a manager so far.

Only this last one is a measure of cash returns or represents liquidity. Venture as an asset class is inherently illiquid. It often takes over ten years for an investment to become liquid; many never do.

This normal state of affairs has not been a major focus in recent years because paper gains have been so fast and high that liquidity was not a concern. But as the valuations piled up and stalled, the lack of liquidity has been a major concern. Without it, new money cannot flow into new opportunities. This has led to things like Tiger Global seeking to exit its positions at a large discount, no matter the price. Liquidity has become more important than value or is seen as the only real value.

My point of view is that the venture asset class has to rethink its structure to consider the need for liquidity and the refactoring of capital into new investments. Waiting more than ten years for a cash return is no longer viable.

There are many approaches to liquidity. The market for buyers of secondary positions is one and is vibrant at the right (low) price. But I prefer combining publicly listed venture vehicles with secondary market liquidity solutions.

Placing capital into a permanent structure (as Andreessen Horowitz did this week and Sequoia before them) makes it possible to express the underlying value of assets in a single unit or share of the holding entity. Of course, as Molten shows, this alone is insufficient. The entity may be valued at a large discount to the asset value. So it has to be combined with a second element - liquidity.

If the holding entity is a public company and also takes part in regular and predictable secondary sales, with the proceeds being put back into investments, then it becomes an asset owner with a growing and recurring income stream. Markets value cash and growth. A company structure with income and high-growth assets solves many of the structural problems to venture capital today.

Seed, Venture, and Growth investors can benefit from this approach by creating a freer cash flow to all parts of the venture ecosystem.

Essays of the Week