Blurred Lines : Late-stage venture — ‘risky business’

Current raft of investors in SPAC’s and many recently IPO’d hyper growth companies are essentially holding portfolios with the same risk characteristics as late-stage private venture.

Decreased friction to go public; the so-called Special Purpose Acquisition Company structure is the fastest-growing method to list. SPACs let companies bypass the IPO hassle and merge into an existing, publicly traded shell company.

Over 200 companies went public last year using the SPAC method — that is more than any individual type of IPO.

This year alone in two months 258 SPACs have been brought to market raising total proceeds of $76.7 billion, just $2.5 billion shy of the total raised in the whole of last year. (Refinitiv data)

As such certain areas of public markets are fast becoming the new late-stage private VC arenas; the advent of investors willing to sponsor this increased level of risk is perhaps at odd with the usual risk allocation one would make in a typical public listed equity portfolio.

Easy access to capital and increased mechanisms by which to access funds have created an incredibly fertile environment for start-ups to grow and test business models — blurring the line between various stages in the capital raising process.

Asset Allocation : alternatives

Alternative investments (known simply as “alternatives”) are investment strategies outside of traditional stocks, bonds and cash.

Some common examples are private equity, venture capital, hedge funds and real estate.

Allocations to alternatives clearly alter a portfolio’s risk-adjusted return. An investment in alternatives typically fulfils one or more of three roles in an investor’s portfolio: capital growth, income generation and risk diversification.

Most typical investment mandates recommend an allocation of between 5% and 20% to alternatives.

Thus assuming just 10% of the current army of retail investors are invested in highly speculative stocks alongside hedge funds and more traditional players; implies that many investors are actually synthetic long venture capital-esque risk.

A Deutsche Bank survey found that almost half of US retail investors were completely new to the markets in the past year. They are young, mostly under 34. Writ large in this huge increase in retail participation is the implicit high level of associated risk taking, especially when observing the focus on MOMO names with a YOLO overlay.

Fun(d) Approach

Typically, five out of ten venture investments fail. Three out of ten are potential ‘life-support’ names’ in which the investor might hope to recoup their partial principal. Only two out of ten investments may succeed providing potentially inordinate returns (’returning the fund’).

Indeed one could look to replicate a VC portfolio payoff with a levered portfolio in the public equity market (where the degree of leverage is altered to factor the level of systematic risk).

The primary ways VCs mitigate risk are: -

(1) time diversification,

(2) stage diversification,

(3), sector diversification,

(4) pro-rata investing over time (scaling in)

and (5) increasing number of investments in the fund.

Risk preference/seeking in public markets has served to erode one of the key would be safety mechanisms utilised by VC’s: valuation buffers. Listed market investors must thus make the trade-off between instant liquidity and current rich pricing whilst also appreciating that their conventional equity holdings are more speculative in nature than they might at first glance appear…

As Citigroup CEO Charles O. Prince, said back in 2007 — “As long as the music is playing, you’ve got to get up and dance”.

YOLO — You Only Live Once, used to express the view that one should make the most of the present moment without worrying about the future.

MOMO — A momentum play is when you buy or short a stock because the stock is moving big in one direction, and you are hoping to scalp a quick gain if the move continues

guv@fuel.vc