Navigating the Cold: How VC’s Winter is
Charting a Course to a Sunnier Future
Matias Collan of ACE Alternatives highlights the VC landscape's current "winter" phase, emphasizing its evolution over the decades and the industry's impending sunnier era. Matias discusses 3 main topics:
1. The Rise of Regional VC Players: Exploring the shift from centralized hubs to a diverse spread of fund managers across Europe, with a spotlight on the Southwest, Eastern Europe, and Germany.
2. Evolving Capital Dynamics in VC: Tracing the journey from a decade of funding challenges to the recent surge in investments across various stages of startups.
3. Tech, Innovation, and Tomorrow's Leaders: Delving into the pivotal role of technology in tackling global issues and the indispensable contributions of young, innovative entrepreneurs backed by private capital.
Can you provide insights into the significant changes you have observed in Venture Capital and Finance over the last 5-10 years?
The VC landscape has seen a dramatic shift. Gone are the days when fund managers were mostly clustered in European powerhouses like London, Paris, and Berlin. Now, we're witnessing a rise in diverse players from regions like the Southwest, Eastern Europe, and notably, Germany.
This diversification is a testament to the evolving dynamics of the VC world. A decade ago, the challenges were more pronounced, with limited funds available for investment, especially for later-stage financing. Over the recent years, the scenario had shifted. There's been more capital flowing into the VC sector, across stages.
Central to the landscape’s evolution is the belief in technology and innovation's transformative power. They're not just tools but solutions to global challenges like climate change and health crises. And it's not just the industry giants making waves. Young, agile entrepreneurs with fresh ideas are at the forefront, and they need financial support. We are more than happy to support this cause, indirectly, recognizing the immense potential that lies in the confluence of technology, innovation, and private capital.
With our current unique macroeconomic climate, how do you believe it impacts the dynamics of investing in Venture Capital?
In today's macroeconomic climate, it's evident that we are navigating a more challenging segment of the cycle. There's been a significant contraction in available capital, affecting both on the LP side, as well as in consequence, on the GP fundraising side. This has led to a decline in valuations and overall capital investments in the VC space.
Given the present trajectory, it is obvious that VC investments and GP fundraising will remain at low levels for the next 10-12 months. But it's not all gloom. Just 12-18 months ago, valuations were notably aggressive, prompting questions about the inherent value of startups. This recalibration might lead us to a more grounded and realistic assessment of startup worth.
For the discerning investor, this climate offers a chance to find well-priced investments. It's all about strategic choices and seeing genuine value over hype. Plus, this environment is paving the way for secondary investments, an intriguing and probate strategy to consider.
Venture Capital as an asset class presents both a challenge of liquidity and the potential for high returns. What do you think about this class of assets in general?
Venture Capital holds a unique position within the PE world, driving socio-economic change. Many startups, backed by VC, have grown into global giants and leading blue-chip companies. This isn't just a U.S. narrative, where top stock-listed companies are tech-driven with VC roots; Europe has its own success tales. Without the support and vision of VC, many of these firms might've never emerged.
For LPs, VC is distinct. It's riskier than other equity classes and choosing the right VC manager can be “make or break”. Navigating VC is an art, blending systematic market screening with relationship-building. It's about identifying those golden picks, the managers that promise not just growth but persistence.
A crucial aspect of this process is spending quality time with VC fund managers to understand their strategies. It's essential to gauge whether they remain consistent in their approach and can weather the varied challenges posed by different market conditions.
How have you observed the evolution of Venture Capital over time?
The Venture Capital landscape is undergoing a transformative evolution. The shift underscores the dynamic nature of the VC world and its adaptability to changing market needs and investor preferences.
#1: Increasing specialization across industry verticals.
Instead of a broad-based approach, there's a growing emphasis on focusing on specific industry verticals. This allows for a deeper dive into narrower markets, enabling VCs to become experts and pinpoint the most lucrative opportunities within their chosen domain.
#2 Segmentation within investment stages.
There's a heightened focus on specific phases like pre-seed, seed, early, and growth. Each of these stages demands different strategies to attract capital, and they present varied risk-return profiles from an investor's perspective. The current sentiment leans away from a blended risk and return approach, which was more prevalent in the past.
#3 Increasing demand for secondary transactions and special situations.
Both founders and VCs are actively seeking secondary liquidity. Such early liquidity events like GP-led secondaries are becoming more sought-after, primarily because they can significantly enhance fund performance. LP-led secondaries on the other side offer a sort of safe haven for instance in situations, were LPs need or want to cash out to readjust their portfolio allocations.
Recently, there's been an increased democratization of access to Venture Capital due to technological advancements. How have platforms like Moonfare and Liquid, which enable individuals to invest smaller amounts in Private Equity, influenced the landscape?
Platforms like Moonfare and Liquid have opened doors to mature funds, such as growth and buyout funds, for a broader audience. While these platforms pool private investors to access top-tier funds typically reserved for seasoned managers, there are considerations.
When pooling vehicles apply the sequential drawdown model, individual investors should closely monitor their liquidity reserves over time.
If these pooling vehicles call for investors' commitments upfront, holding large undeployed cash can affect the fund's overall performance.
Can you comment on the role of companies like Vauban, Bunch, Roundtable, and others who are facilitating SPVs at scale?
These platforms have been pioneering the approach of pooling capital into dedicated single-asset vehicles i.e., SPVs. These entities have carved a niche for themselves in the market, especially when there aren't extensive financing needs but more regulatory requirements.
However, their value proposition is less when situations become more intricate. For close-end pooled funds, where more complex operations are required, this type of streamlined service does not necessarily work out that well.
Given these developments, how do you perceive the current status quo in Venture Capital?
The Venture Capital landscape has evolved significantly. Investors and fund managers now exhibit greater transparency and responsiveness, especially in LP onboarding and fund signings, thanks to digital technology integration. There's also a heightened focus on domain expertise, driving the industry with deeper insight, proficiency and efficiency.
What are your predictions for the future of Venture Capital considering these trends?
Venture Capital will undoubtedly continue to be an asset class that attracts capital allocation. Investors recognize and value the place VC holds within their portfolio considerations, especially given its ties to technological innovation. From a geopolitical perspective, the VC landscape is poised for growth and is determined to thrive.
VC is pivotal for global challenges as it has always fueled the visions of leading inventors and entrepreneurs, giving rise to advancements like electricity, computers, and the internet. Without this financing and risk-taking, progress halts.
For instance, the U.S. invests approximately 10 times more per capita in innovation and growth than Germany. Germany's investment has decreased over the years, going from roughly 4% of real GDP during 1950-1970 to about 1% between 2000-2020. To stay globally competitive and safeguard prosperity, it's essential to prioritize increased investment in innovation and growth.
Atomization is a growing trend in the landscape. What implications do you think this has for founders and the broader market?
Atomization of investment funding in the early stage introduces complexities for founders. When aiming to raise capital, fragmented cap tables can pose challenges in organizing rounds and establishing syndicates, making the funding process more intricate.
Proper cap table management becomes paramount, and leveraging the right tools is essential. At ACE, we have built an automated Captable calculation and documentation system that is able to reduce 90% of time currently required for the coordination of these tables.
Do you foresee private markets becoming as liquid and transparent as public markets in the future?
While the allure of private markets becoming as liquid and transparent as public ones is enticing, by definition, it's a challenging proposition. The reporting cycles in private markets differ, and their price-finding mechanisms operate uniquely. Unlike public markets, there isn't consistent price-finding on a daily or even weekly basis, presenting conceptual challenges.
However, it's worth noting that private markets have seen significant improvements and have become crucial instruments in the financial landscape. By nature, the private market remains less liquid. While we might not witness tectonic shifts in the immediate future, advancements in technology and AI could potentially influence areas like benchmarking and transaction facilitation.
Do you consider a shift towards increased liquidity and transparency in private markets to be beneficial or detrimental?
Increased liquidity and transparency in private markets are, in my view, always beneficial. When we consider the dynamics of demand and supply, it's evident that greater transparency facilitates better understanding and decision-making. As investors seek exposure to specific assets, enhanced transparency in areas like asset valuation and performance will invariably lead to more accurate and fair pricing.
In your experience with General Partners (GPs) and Limited Partners (LPs), what types of LPs and GPs have been resilient and prosperous during these challenging times?
With fewer LP commitments to VCs anticipated in the next 12-18 months, many VCs will struggle to raise funds, prompting more selective investments. This pivotal period, while presenting short-term challenges, promises long-term benefits for the innovation sector. Committed LPs stand to gain, and we'll see quality VC firms emerge to support entrepreneurs. As we undergo this reset, LPs must confront some hard truths and assess which of their portfolio companies will stand the test of time, remaining viable in 15 years.
On a more positive note, investment programs entertained by EIF and KFW Capital or EIF and other governmental initiatives keep playing a very crucial role, enhancing the stability and success of both GPs and LPs.
As you interact with both emerging managers and experienced veterans in the field, could you share some key learnings about how digital products have transformed the financial market?
Two primary observations emerge:
#1 Streamlined fund setup and reduced infrastructure costs for emerging players:
Innovative tools have simplified the process of setting up funds, especially for emerging players. These tools not only enhance investor engagement, simplify lifecycle event management and handle accounting, but are also at a reduced price point.
For instance, at ACE, the lowered infrastructure costs and ability for automation through tech now allow us to serve smaller, competitive managers, something that was previously challenging. Although, it is important to note that the success of this is not only through efficient digital processes but also decades of domain experience that allow us to create such niche efficiencies.
#2 Outsourcing Trend Among Established Investors:
For seasoned investors, there's a discernible shift towards outsourcing fund operations. The challenge of staying updated with constantly evolving systems is considerable. As these investors grow their teams, leveraging technology for scaling becomes crucial. Falling behind in this race introduces operational risks. This inclination towards partnerships and outsourcing underscores a significant trend in the industry.
What are your recommendations for Limited Partners who are looking to invest?
10 Key factors of alignment you should always consider when choosing any private market fund.
#1 Prioritize Track Record
Always prioritize the track record. It's essential to scrutinize the team's past performance and achievements closely.
#2 Synthetic Track Records for New Teams
For newer teams presenting a novel fund, the absence of a traditional track record can be challenging. In such cases, consider creating a synthetic track record to gauge potential.
#3 Examine Cost Structure
Delve into the cost structure. Lower management fees mean more profits flow to LPs rather than the GP. Fair market rate fees should be expected.
#4 Assess Access to Deal Flow
Evaluate the deal flow funnel. Emphasize primary/native access and direct connections to key founders. Additionally, exercise due diligence when reviewing service providers, ensuring they offer high-quality services and valuable investor insights.
#5 General Partner Commit:
The amount of personal capital the GP invests in their own fund “more skin in the game” aligns interests.
#6 Carried Interest:
The share of profits the GP receives is key. Fair carry structures are better aligned.
#7 Clawback provision:
Policies that allow LPs to recoup carry from GPs if deals later underperform help align downside risks.
Open and consistent communication/reporting fosters trust and accountability.
#9 Key Person Provisions:
Rules for continuity if key partners leave help reduce key person risks.
#10 Fund Governance:
LP advisory committee and consent rights help oversight but are secondary.
Lastly, could you introduce us to your company, ACE Alternative? What is its role within the Venture Capital and Finance ecosystem?
We believe that our customers and their decisions are instrumental in shaping the world we live in. It is also our belief that the quality of decision-making processes is a function of clarity and peace of mind.
At ACE, we support our clients in their fund operations through a combination of tech-driven approach and domain expertise. Our mission is to give our clients a peace of mind regarding their back office and so help them focus on their primary priorities: discovering investment opportunities and delivering returns.
Can you share your vision for ACE Alternative's growth over the next five years?
Our aim is to become the leading managed service provider for the VC and PE community on the European continent, recognized by our customers as the partner of choice thanks to the power our innovative technology platform and the deep domain expertise and strong dedication of our team.
About Matias Collan
Born in Finland, Matias embarked on his distinguished career in Frankfurt, initially serving as an attorney specializing in corporate law and financial transactions. Subsequently, he transitioned to the realm of investment banking. In 2007, Matias was appointed Operating Partner at Earlybird, one of Germany's most prestigious venture capital firms and setting stage for his current position. His journey then led him to Luxembourg in 2013, where he aligned with family office investments, primarily focusing on technology and renewable energy sectors. Recognizing an emerging demand for specialized services in fund operations after several German business friends reached out in 2019/2020 seeking senior support in fund operations, Matias founded ACE Alternatives a 360-degree managed services ecosystem for alternative asset vehicles in 2021.
About ACE Alternatives
ACE Alternatives (“ACE”) is a NEO-managed services provider in the Alternative Assets space, focusing on venture capital, private equity, fund of funds, private real estate and more. Through innovative tech-driven processes and decades of industry expertise on the operating side, ACE provides flexible and customized solutions for fund managers looking to outsource their fund administration, compliance, tax & accounting and ESG needs.