The venture capital market has thrown fund managers and limited partners a number of curve balls in recent years, compelling some players to rethink their investment strategies and others to leave the game altogether. Returns on VC investments have been low and slow to come. Federal regulations governing medical discoveries and devices have tightened up. Rapidly evolving technologies have presented a constantly moving target that is hard to hit. Corporate newcomers with deep pockets have thrown their hats into the ring, creating stiff competition for traditional venture investors and limited partners, who find it increasingly difficult to achieve capital efficiency and generate decent returns.
During an afternoon panel, a group of VCs and LPs discussed their strategies for making money in a sector that presents both daunting challenges and promising opportunities.
“We discontinued making venture capital investments,” reported Martin Sutter, founder and managing director of Essex Woodlands. Over time, the firm gradually shifted the investment focus of its life sciences and health-care funds in response to poor VC market performance and returns. Of eight funds launched by the firm, the first three were early stage funds that did well, but didn’t return capital to investors until years 10 through 12. The next three were mid and late stage funds that had unacceptable loss ratios. The seventh and eighth funds focused on growth equity investments in companies that were already in the revenue stage. Sutter said Essex Woodlands funded 28 growth equity companies and exited 13 within four years with a 28% gross return on investment. “The VC exits were half that and took twice as long,” he reported. “Venture capital investing didn’t work for us, so we gravitated toward more success.”
Robert Manilla, vice president and chief investment officer of the Kresge Foundation, which has a $3 billion endowment, said the philanthropy is selling $85 million of venture investments in the secondary market. He attributed the decision to pare down that portion of the portfolio to the poor returns limited partners have received from their VC investments. “Venture capital has not been worth the trip,” he said. “Our current 10% allocation in the sector will go down to 5%.” While Kresge will continue to reinvest in this space, VCs will have to prove they have a competitive advantage before the foundation will commit more investment dollars, Manilla remarked. “We invest with people who are smart and intelligent, and we want their strategies to change over time, if they have a rational reason,” he added.
Jon Lauckner, president of GM Ventures, presented an upbeat assessment of his equity investments in start-up companies that are developing next-generation automotive technology. “We only do direct investments and look for very specific technologies in five key areas,” he explained. “If a company can develop and validate its idea, we’ll buy it.” Lauckner noted that corporate VC investors have a huge advantage over traditional venture investors focused on financial returns. “One of the big problems for start-ups is finding that first customer,” he said. “Other investors can never be customers to their companies, but we can buy or license a company’s products. And all of a sudden, a start-up is on its way.”
Getting an idea for a new technology in the door at GM Ventures is only the first step, however. “We evaluate these technologies and if they pass the test, we ask for proof of concept or a prototype,” Lauckner said. “If the prototype works, we’ll do joint development with the company and a Tier 1 or 2 supplier. No value is created for our core business until we get the product commercialized. It’s not enough to use money to create a financial return. There has to be a bigger purpose for us.” GM Ventures typically asks companies for a year or two exclusive on new technologies in order to gain a competitive advantage. Often venture investments are made through a syndicate with other corporate investors and VCs.
Ned Hill, managing director of the Mercury Fund, reflected earlier comments by keynote speaker Kelly Williams about the fast improving venture investment climate in Michigan. “We’re very excited about investing in Michigan,” he said. “The state’s strong entrepreneurial ecosystem presents tremendous opportunities.” Although access to capital will always be an issue, he urged entrepreneurs to be persistent and believe in their ideas, because the venture industry does have capital available. “We’re very active in venture capital and just did a deal here in Michigan,” Hill remarked.
For our readers: Do you agree with panelists who have exited venture capital or with those who continue to invest in the sector? What shifts would you consider making in your investment strategy to deal with challenges and capture opportunities?