Investing in Publicly Traded Venture Capital Firms
If you think plunking down $98,192 for ten months of education sounds a bit extreme, you’re not alone. Yet more than 58,000 people have done just that to go through the INSEAD MBA program in hopes of taking their careers to a new level. The man who founded INSEAD, Georges Frédéric Doriot, had a knack for figuring out where to make a buck. Mr. Doriot is also considered to be the father of venture capital when in 1957 he invested $70,000 for a 70% share of DEC which was later acquired for $9.6 billion – the largest merger in the history of the computer industry at the time. Since then, the venture capital industry has thrived with more than 1,000 venture capital firms managing in excess of $400 billion.
For retail investors, the venture capital domain has largely been off limits. In order to become a “limited partner” and place money with a venture capital firm to invest, you need to be wealthy and connected. As for the alternatives, there aren’t many. Very few venture capital firms are publicly traded. Who wants to deal with all that extra paperwork? Still, there are some. Anyone remember TINY?
Valuing a Public VC Firm
Anyone who has been a Nanalyze reader since back in the day knows the story of Harris and Harris Group (now called 180 Degree Capital) which used to be a publicly traded venture capital firm that invested in nanotechnology startups and now trades under the ticker TURN. The idea of owning a portfolio of startups sounds really exciting, but when it comes to performance, the company has fallen flat. More recently they’ve shifted their strategy from a publicly traded venture capital firm to a business development company (BDC) representing a closed-end fund that invests in small-cap public companies with a “constructive activist approach.” In other words, they want to move from holding a collection of startups to holding a collection of small-cap stocks. The method you would use to value TURN will consequently change as follows:
- BEFORE: The value of the company would be roughly equal to the value of all startups being held, minus debt, plus cash
- AFTER: The value of the company would be roughly equal to the value of all stocks being held, minus debt, plus cash
It’s much easier to value a portfolio of publicly traded stocks than it is to value a collection of startups. That’s because publicly traded stocks are actively traded and have a price-per-share that anyone can quickly reference. For startups, the value is generally determined by what valuation investors ascribe to the startup when they fund it. With each subsequent funding round, the value of the startup typically increases. (If it doesn’t, it’s often referred to as a “down round.”)
For companies like TURN, the value of all startups or stocks being held at any given moment is referred to as the net asset value (NAV). Consequently, it seems reasonable to expect that TURN’s NAV should be roughly equal to TURN’s market cap. In other words, the total value of the company should be the sum of its parts. However, that’s not always the case.
The Trendlines Group
We recently came across a publicly traded venture capital firm called The Trendlines Group which trades on the Singapore Stock Exchange (TTGL:SP) and in the U.S as an American Depository Receipt (ADR) under the ticker TRNLY. Unlike TURN, Trendlines Group is a collection of startups with a geographic focus on Israel and Singapore and a thematic focus on agtech and life sciences. It’s an interesting little company which provides some insights into how a venture capital firm operates. Here’s a look at some basic financials for 2019:
The first line under income shows the value of their portfolio companies increasing over the year by $3.753 million. They also collect income by providing services to their portfolio companies which is quite clever. Consequently, portfolio appreciation/depreciation and selling services to portfolio companies make up the majority of the company’s income. As for expenses, they have the usual operating/general/admin stuff which constitutes the majority of the $9.685 million in expenses for this 40-person company. Where things get interesting is when we start looking at the NAV discount.
Right now, the NAV for Trendlines sits at around $102.8 million of which the majority consists of shares in the below ten startups:
Pretty cool, right? You can purchase shares of Trendlines Group and get exposure to a diversified collection of Israeli and Singaporean startups, one of which, Hargol, we recently covered in our piece on 8 Israeli Alternative Protein Startups. Another name on the list, MetoMotion, was featured in last year’s article on 14 Agricultural Robots Making Farming Easier. There are also plenty of names not seen above as Trendlines Group has invested in around 57 startups total (as of December 2019). The total value of all startups in their portfolio sits at around $102.8 million while Trendline Group as a company trades at a meaningful discount to that number as seen below.
In other words, you’re acquiring an asset for $3.92 a share that’s worth $6.30 a share. So, let’s try to think through some of the main reasons why this NAV discount exists.
Explaining the NAV Discount
There’s a financial concept known as arbitrage which is loosely described as purchasing an asset for less than its real value and then selling it to someone else and immediately capturing the value difference. Arbitrage takes advantage of market inefficiencies, and therefore is usually noticed and capitalized on very quickly. If there was value to be had in capturing this NAV discount, someone would have already captured it. If you were to ask the company about this NAV discount, they’d likely use some benchmarks to demonstrate how their NAV discount compares to that of their peers (what the industry calls “comparables”). That’s what they’ve done here:
So, why does this NAV discount exist? We can think of at least a few obvious reasons.
Firstly, the failure rate of startups is much higher than you think. All these Twitter want-trepreneurs complaining about how no venture capital firm will throw money at their inner-genius don’t realize that ideas mean nothing. Execution is everything. Then, you can execute perfectly, and still fail. In the latest Trendlines investor deck, mention is made of “57 portfolio companies as at 31 December 2019; 34 written-off portfolio companies not included.” This means that 37% of the companies that Trendlines funded failed. Consequently, there’s a great deal of risk being priced in here for future failures. For life sciences companies – of which Trendlines is weighted heavily – it just takes one dead person to rain on your parade.
Secondly, there’s this notion of liquidity. If you purchased Trendlines – the entire company – and then tried to liquidate their holdings, you need to find buyers for those shares. Sure, you might be able to offload some on the secondary market, but only in smaller amounts. This is a good segue into talking about how investing in publicly traded VC firms differs from buying shares of startups on the secondary markets.
One way to buy shares in startups is through secondary markets we’ve written about before like fintech startups SharesPost or EquityZen. The difference between a secondary market and a publicly traded venture capital firm is that you’re not letting an experienced professional decide which startups have the most potential, when you ought to invest in them, and at what valuation purchasing shares makes sense at. You’re simply buying shares from an existing shareholder at a price they’ve decided upon. The minimums are often $25,000 USD and upwards so it’s not that accessible to most retail investors who don’t want to commit that much capital to an investment that has very little liquidity. You’ll also pay the secondary market a commission on the purchase or sale of shares, and it’s going to run in the four-figures. Typically, you’ll need to be an accredited investor – annual income exceeding $200,000, or $300,000 for joint income or assets of $1 million or more – which squarely excludes the middle class. As you can see, the world of venture capital excludes the majority of retail investors. That’s the appeal of publicly traded venture capital firms.
Investing in publicly traded venture capital firms provides a form of diversification since the returns won’t be overly correlated to the public markets. Therein lies part of the problem. While publicly traded VCs may not be correlated with other stocks in your portfolio, they certainly aren’t outperforming them. TURN has been a complete flop ever since their share price rocketed during the days of nano hype in the early 2000s back when most of our MBAs were selling weed to fund their college educations.
Trendlines is an interesting investment because they’re so transparent about their operations. If you want to learn what it’s like to run a venture capital firm, you couldn’t go wrong by picking up some shares and reading their financial reports since you’ll have some skin in the game. There are also some other publicly traded VCs out there that may be worth looking at, and we may do just that in coming articles.
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