Like it or not, venture capital as an opportunity – albeit a risky one – for private investors has become increasingly widespread.
Until a few years ago, those who put money into early-stage private companies did so through tax-efficient venture capital trusts (VCTs), which benefited from direct tax subsidies to help offset the higher risk assets implicit in those investments.
Since then, venture capital has moved into more mainstream investments through investment trusts. The most notable example is the long-established UK-listed fund Scottish Mortgage, which recently attracted attention following a boardroom breakdown – much of which was focused on the emerging private asset book of venture capital.
RIT Capital Partners, another well-respected Financial City institution, made a huge profit on its venture capital investments in 2021, but analysts at Investec recently noted that the subsequent returns were poor – and the payments to fund managers were quite generous. This comes on the heels of intense scrutiny of Jupiter’s Chrysalis Investments, which suffered huge losses when its valuation plummeted in the wake of the pandemic.
These high-profile cases underscore the trend toward democratization as more experienced venture capital groups list their vehicles on the London market. These include not only Chrysalis Investments, but also Molten Ventures (formerly Draper Esprit), Augmentum in the fintech sector and Seraphim Space in the space sector.
Much of the attention in major market VC investing has been focused on fees and liquidity issues – how quickly can you sell a position that’s in trouble?
But the real focus should be on how do you really value these private assets and businesses? In the table below, I have listed the current NAV discounts for the major publicly traded venture capital funds. You will notice that the market is telling us something. For example, if the fund manager values something at £1, then the market is saying that this £1 could be worth between 60p and 50p.
Valuation of venture capital trusts
Discount to the fund’s NAV as at 4 January 23 (%)
Lava Ventures 73
Schiehalin 40
Schiehalin C 48
Six Winged Angels Space Trust 58
Enhanced 38
Chrysalis Ventures 53
The main reason for this valuation conundrum is that funds are reporting historical numbers and the market is discounting future discounts as the funds’ valuation models react to deterioration in certain sectors of the private market.
Let’s take Chrysalis Investments as an example. Its disclosures and the timeliness of its valuations have improved considerably in recent months. Back in the summer of 2021, one of its major investments, the “buy now, pay later” fintech Klarna, was said to be worth $46 billion. A year later, that figure was significantly reduced by $6.7 billion.
As a result, Chrysalis had to cross off the marker on the net asset value (NAV) of its own funds. in February, it reported a NAV of 128 pence, down from the last comparable figure of 237 pence reported in February 2022.
Is a haircut enough? Trying to come up with alternative measures is almost impossible, but there are some useful guidelines. In the public markets, Cathie Wood’s Ark stable of ETFs invests in many early-stage technology companies that existed in typical VC portfolios just a few years ago. Her innovative ETF is filled with small tech stocks that are former prodigies and are down nearly 60% since the start of January 2022 (the beginning of the tech crash).
If those listed stocks in Ark’s portfolio are down 60% in that time (and we have good visibility into those numbers because they are publicly available), then it’s not unreasonable to think that private, unlisted companies – which are typically more immature and riskier than they are – -not unreasonably so for their publicly traded peers-face even greater declines in value.
My hunch is that late-stage, pre-IPO businesses that figure prominently in Chrysalis’ portfolio may be fairly accurately priced down, although the headline figure may be another 10% to 20%.
This makes me more cautiously optimistic about Chrysalis’ position and share price – I have started buying more shares very slowly. I think highly of Molten Ventures as a full-service, full-stage venture capital firm that is off to a good start in revaluing its assets – although it may not have enough of a deficit in my opinion.
But that steep discount offers you some protection, and Molten also insists that its focus on investing through preferred stock – a class of stock that gives investors more power – could better protect its position. Still, it may not matter what class of stock you own if the joint venture collapses worthless because it runs out of cash.
My guess is that the space industry will probably be out of favor with mainstream investors for some time
David Stevenson
Another positive I see is that the Ark Innovation ETF I mentioned has shown signs of life, up 29% year to date. I don’t think this indicates that all the pain in the tech sector is over, but it does indicate to you that once valuations are in line with reality, there will be buyers out there.
Another positive is that the European venture capital space is still lagging far behind the U.S. Once this cycle turns, there is a good chance – but not certain – that European VCs will see a strong rebound.
The bad news is that these early-stage investments have a long cycle. According to one academic who studies deal flow in the U.S. venture capital industry, it took more than 17 years for investments in the (mostly U.S.) venture capital market to recover from the crash of 2000.
One way to understand how this cycle works is to look at the change in valuation of late-stage, pre-IPO companies versus early-stage or even seed-stage deals. I don’t think the former are far off from reasonable numbers, while the valuations for the latter – the riskier stuff – are still slightly insane. I see a lot of examples of ridiculous numbers.
Another concern is that public market venture capital firms may not have enough cash to make follow-on investments. In short, if valuations are starting to approach reasonable levels, one could argue that now is the time to start accumulating cash for deployment. By my count, Chrysalis had only £69 million in cash before its recent top-up of its Starling investment, while Molten reported £28.5 million in cash at the PLC level.
By comparison, a US-listed venture capital firm called Sutter Rock Capital or Surocap has $125 million (and a market capitalization of just over $100 million) of investable capital on its balance sheet, with a net asset value of about $3.60 relative to a share price of $7.39 per share. In fact, it is worth less in the market than its net cash – and cash is king these days.