Some LPs show support as VCs stray into stock market

Pension plans, endowments and other limited partners of the private markets allocate a substantial part of their total assets to public equities. Those investments are usually made with the help of traditional asset managers.

But this year, an unexpected group of investment managers has also begun to dabble in the stock market: venture capitalists.

Amid a dearth of private market deals stemming from a valuation disconnect between investors and founders, some VC firms are buying public equities directly in the open market, via secondary offers or through private investments in public equities, known as PIPE transactions. Meanwhile, these firms are slowing their venture investing.

Since most LPs already have public market investors, why would they want their venture managers to allocate to the same asset class, with a much higher price tag? Venture capitalists generally charge their LPs a management fee of 2% or more, about double what it may cost to have capital managed by a traditional public investor.

Despite the higher fees and, in some cases, unnecessary additional stock markets exposure, LPs with committed capital have no choice but to accept VCs' approach to public investing.

"We are supportive of VCs investing in public companies in select cases," said Brijesh Jeevarathnam, global head of fund investments at Adams Street Partners, an LP of firms known to use this strategy, such as Accel and Andreessen Horowitz. He said there are some situations where "VCs have an edge versus the generic public market investor."

In cases where a VC was also an investor when the company was still private, the VC may have a deep understanding of the company's strategy, management team and growth prospects.

Those insights can help VCs make a bet that, in three to five years, the stock will appreciate and "earn a very attractive venture-like return," Jeevarathnam said.

The current environment allows investors to take advantage of an arbitrage-like strategy between the low stock prices and high valuations entrepreneurs are still expecting for their late-stage startups.

"In an environment where public market quickly reset and the private markets [dealmaking] has slowed, some investors are spending more time in the public markets," said Miguel Luiña, the head of global venture and growth equity for Hamilton Lane, which advises LPs and backs venture funds.

Even though some LPs are on board with VCs investing in public equities, it does not mean they are ready to give fund managers carte blanche to pursue this strategy.

While public and private markets investing generally require different skill sets, there is some overlap.

Venture firms reportedly investing in public equities include Lightspeed, Accel, Sequoia and Andreessen Horowitz. All are multistage firms with significant experience investing in large late-stage tech companies, which in some ways resembles investing in their publicly traded counterparts.

"I don't think [public stock investing] is out of everybody's wheelhouse, but it's out of some [investors'] wheelhouses," he said, adding that LPs would be concerned if early-stage funds entered public equities.

Private market investors also want to be sure that VC funds have a small allocation to public equities.

Traditional venture firms can invest up to 20% of their vehicles outside of startups. But firms like Andreessen  Horowitz, Sequoia and Bessemer have registered as investment advisors, a regulatory distinction that gives them more leeway to take bigger positions in crypto and other assets outside of classic venture deals.

These RIAs aren't legally restricted from buying more public stock, but LP agreements generally prevent them from veering too far from their core strategies.

"None of our GPs ever got close to investing 20%" of a specific fund in public markets, Jeevarathnam said, adding that the typical amount is closer to 5% or 10%.

Some LPs also expect venture capitalists to take a multiyear view of the stock market.

"I don't think anybody is buying shares for a three- to six-month holding [period], hoping for a quick pop," Jeevarathnam said. "This doesn't happen with our managers because we would push back, to be honest."

However, a bigger concern about this strategy is the higher management fees compared to public markets managers.

But these concerns are not fazing VCs.

Featured image by ymgerman/Shutterstock

This article originally appeared on PitchBook News