Smart judgment will outweigh dumb luck in the venture capital world

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The writer is the founder of Sieve, Media site for European start-ups

Most of us occasionally experienced a crisis of confidence in our career choices and hankers after becoming a ski bum or monk. Still, I was impressed with the recent conversations with venture capital investors that seemed to be successful. Why work hard to scrutinize the world for breakout investments when you can make more money by buying an index tracking fund and sitting on the beach?

As my FT colleague Patrick McGee calculated, Apple’s stock market value has increased by more than $ 700 million on average 1 day The last 10 years. Even the best VC investors can’t generate wealth on such a scale.Implicitly acknowledging that reality, the legendary Silicon Valley venture capital firm Sequoia has declared it.The investment has no “expiration date”. This allows Sequoia to break traditional VC practices and continue to invest in high-tech companies after the initial public offering.

Many successful start-ups, such as Apple, have gained a strategic advantage over the decades and have accumulated much of their post-IPO value. Sequoia’s partner Roelof Botha recently wrote.

Ironically, institutional investors are becoming more enthusiastic about the attractiveness of the early private markets, as venture capital investors become more and more envious of the late returns available on the public market.According to the report by Data company Preqin Institutional investors announced this week continued to invest in venture capital funds in 2021 and traded in the private market, attracted by the recent surge in returns. Preqin’s Venture Capital Index has an annual rate of return of 37.2%, ahead of most other asset classes. Over the last five years, VC funds have increased their assets under management from $ 547 billion to $ 1.7 trillion.

However, as always said, past performance does not guarantee future results. Given the world’s cheap sea of ​​capital, most asset managers find it difficult to lose money in the last few years.But the market is rising inflation Expected further rise in interest rates It confuses investment calculations. Already this year, we have seen a significant rotation from listed “speculative technology” stocks to value companies. Ark Invest, a high-profile fund run by Cathie Wood, has been particularly hit. “Spec-tech is wrecked.” As one investor said..

It seems only a matter of time before the technical evaluation of the public market declines and the private market is also infected. Recent inflows into this sector have pushed valuations into the area of ​​unsustainable nosebleeds. Rising interest rates will also make life in the VC industry difficult. Institutional investors will be more risk averse And in a higher interest rate environment, there is less willingness to allocate funds to VC funds. The higher the cost of capital, the lower the rate of new business formation and the more difficult it is for young companies to grow.

“I think there’s a fix, which is inevitable,” says Professor Josh Lerner of Harvard Business School, who has studied the VC sector. He states that many of the “madness” associated with the dot-com crash at the turn of the century have similarities today. “Watching unsuccessful movies from 1999 to 2000, especially for’tourist’investors who went to the arenas they didn’t know much about. “

The methodology is controversial, but after deducting the charges, VC returns this century were lower than those Created with similarly risky assets in the public market. However, the overall return of the sector masks the big difference in performance between the best and the worst of such funds. We are probably at that stage of the cycle of wise judgment again claiming stupid luck. Choosing a winner will be more important than surfing the market.

In addition, the debate about investing in VC funds is that long-term technology trends outweigh short-term market volatility. As Professor Lerner says, there have been fundamental changes in the way innovation is pursued in many economies. Venture capital-backed start-ups, rather than large ones, have proven to be the best innovation engines in most cases when it comes to leveraging new technologies and creating new industries.

My VC acquaintance has good reason to leave the beach.

john.thornhill@ft.com

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