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5 December 2018

Issues in the VC industry and how VNX Exchange will solve them

Venture capital (VC) and private equity (PE) are infamous for long capital lock in, which ultimately spells illiquidity. In the recent years this problem has only been getting worse with more and more companies opting for “a staying private” strategy and dodging initial public offerings (IPOs).

Venture capital (VC) and private equity (PE) are infamous for long capital lock in, which ultimately spells illiquidity. In the recent years this problem has only been getting worse with more and more companies opting for “a staying private” strategy and dodging initial public offerings (IPOs).

Uber and AirBnB are just a couple examples of companies choosing to remain private, but there are now roughly 300 “unicorns” collectively worth about $1 trillion dollars, and the list is growing. With Elon Musk recently revealing plans to take Tesla private, and Facebook and Twitter taking a big hit on their capitalisations due to earnings updates, there’s a risk that even fewer of these private tech companies will want to go public.

This is causing a new phenomenon  — the rise of  a new class of secondary buyout funds with their crosshairs aimed at late stage pre-IPO companies, mostly through buying out previous investors. The best-known of these is the famous SoftBank’s $100 bln vision fund, but many other VC and PE firms are also tapping into this space (eg. NEA recently announced a $10 bln buyout fund). As a result, the problem is only getting bigger for the industry – capital lock in is also on the rise. On average, it now takes 13 to 15 years to liquidate a VC fund.

What’s more, the sustainability of classical PE/VC models is now a major doubt in the wake of the blockchain-fueled startup financing boom that take advantages of of ICOs. Most of these concerns are linked to increasing capital concentration, fewer exits, increasing holding periods, and exaggerated paper valuations used to raise new funds  —  all causing GP/LP misalignment.

VNX Exchange enters this industry intent on fixing many of these problems by boosting liquidity for the venture industry.

The problem with liquidity is initially caused by a few main factors:

  • The main source of capital for the VC industry has historically been the “long money” of pension funds and insurance companies. For them, the historical 8+2 (years) formula worked fine as they didn’t need the money too early, and were using PE/VC as a long term investment instrument. Beyond this initial capital base, for the majority of capital market investors (like hedge funds, banks, or family offices) these holding period are just too long.

  • VC has historically been a closed club with only a few players making the most money, getting the best deals and taking the most capital from large institutional investors. For them, the capital lock in isn’t causing any problems as they are cash-rich. However, as the VC market started rapidly growing and more than doubled over a decade, adding new fund managers, corporate VCs, mega-angels, investor clubs, and other new entrants, a new “outer” circle of 2nd tier VC firms has been created. For them the old industry principles don’t work as raising capital for new funds is much harder, and sustaining there business without it is much more difficult as their income is tied to and entirely dependent on management fees from new funds, especially as many of these new players have not been around long enough to receive a carry payment. So there’s more pressure on their shoulders to find new ways of financing their capital needs.

  • Finally, for many years information asymmetry has been a major feature and source of competitiveness in the VC/PE space. The ability to exploit these asymmetries has been one of the success factors for many VCs and their portfolio investments. This factor is relying on the ability of private companies to avoid any excessive public disclosures, often leaving no public trace of what they are doing, while raising billions of dollars in “stealth” mode. At the same time, as decision making and investment decisions in VC are becoming more and more data driven, and more public sources of data emerge to track private company performance (eg. CB Insights’ “Mosaic” startup intelligence platform), the entire privacy and secrecy play stops being a sustainable competitive strategy in VC investing.

At VNX Exchange we see that these rapid changes are essentially decreasing the impact of the above factors, making the status quo less appealing to everyone, and creating an opportunity for change. With more investors involved and a proper infrastructure and ecosystem in place, enabled by technology, it becomes possible to change how the VC market operates.

By growing the VC investor base through a compliant and secure secondary market, where nearly anyone can buy a “stake” in a VC or PE fund and sell it at any time, we believe that a marketplace like ours will be able to mobilize capital and increase its velocity, giving both existing LP and GPs, as well as new investors coming into this asset class, higher returns, and increasing the total capital allocated to VCs, and promising startups VNX Exchange is built in a way to address existing stock market deficiencies, in order to make it extremely easy and cost-effective for any VC fund manager to raise capital through the VNX platform and for any investor — institutional or private — to invest into VC as an asset class, while avoiding the historical hurdles of high minimum ticket sizes and long capital lock in.