Patient Capital: The emergence of Hybrid Venture Capital Funds
Innovation in the VC industry as a Plea for Long-Term Vision.
In this issue, we take a break from the Emerging and First-Time Manager series to venture into innovation in the Venture Capital industry. As a big supporter of the idea that there is opportunity in crisis, we think that we are at a moment where our industry has the chance to step back, take a breather and have a critical look at how we can adapt to changing times ourselves.
TLDR:
Hybrid Venture Capital funds break with the traditional model of the closed-ended fund to provide more flexibility to Limited Partners and Portfolio Ventures alike. Liberated from the constraints of the 10 year time horizon, some VCs prioritise a long term vision, explore flexible asset allocation options and give themselves the possibility to stay committed to their portfolio ventures in the long run.
In the dynamic world of Venture Capital, change is not just a constant; it's a catalyst for innovation. For us optimists, the current climate of funding morosity provides an opportunity for innovation to shine, and innovation loves nothing more than the turmoil of a crisis to come up with disruptive concepts. No better time to explore new ways how Venture Capital can serve its clients better, on both sides of the value chain.
Traditional venture capital funds have long been synonymous with their closed-ended structure and rigid 10-year time horizon. However, the emergence of hybrid venture capital funds is challenging this status quo, revolutionising the industry and reshaping the way we perceive investment strategies. In this article, we dive into the rationale behind the rise of hybrid VC funds, explore their distinctions from traditional counterparts, and shed light on the potential advantages and challenges they bring. As we navigate this evolving landscape, the lens of Soft Due Diligence remains crucial, ensuring that innovation and long term value creation continue to be at the forefront of these strategic shifts.
The Genesis of Hybrid Venture Capital Funds
The advent of hybrid venture capital funds can be attributed to several factors that reflect the changing dynamics of the investment landscape. One of the primary drivers is the recognition of the limitations imposed by the traditional closed-ended structure and lengthy investment horizons.
According to Sequoia Capital, who already redesigned their entire strategic concept around the principle of a hybrid fund in 2021, the traditional 10 year closed-ended structure does not match the ambition of their portfolio companies anymore, nor does it match their own. Successful portfolio companies might take longer than 10 years to mature in a sustainable way, and in their role as an investor, VCs see value in prolonging their relationship with certain portfolio companies beyond an exit or even want to continue holding shares after an IPO.
With their restructured “Sequoia Capital Fund”, Sequoia Capital bets on a liquid portfolio interlacing public positions in portfolio companies with investments in underlying closed-end sub-funds that return capital and benefit to the mother fund. In addition to classic Venture Capital investments, the new fund will not shy away from other asset classes, such as cryptocurrencies for example.
Sequoia aims to cement their engagement with portfolio companies, while at the same time offering better value to their Limited Partners. The new fund strategy obviously increases diversification and limits exposure to risks. But the most impactful feature for Limited Partners is to benefit simultaneously from long-term ambition and increased liquidity.
Hybrid funds introduce a more flexible structure, allowing investors to access capital and realize returns at various stages of the fund's lifecycle. This adaptability aligns with the ever-changing pace of the technology and startup ecosystem, where agility and speed are key drivers of success.
Distinguishing Features and Potential Advantages
Hybrid VC funds deviate from tradition by offering more fluidity in terms of fund structure, exit strategies, and investor engagement.
Unlike traditional VC funds, which often lock up investors' capital for the entire duration of the fund, hybrid funds enable periodic liquidity events, allowing investors to exit or enter at different intervals. This innovation not only caters to the preferences of modern investors seeking more control over their investments but also fosters a sense of partnership between fund managers and Limited Partners. By embracing this flexible approach, hybrid VC funds can potentially attract a wider range of investors, thereby expanding their network and access to capital.
This flexibility comes with a price and hybrid funds face specific challenges: a rolling fund structure with capital calls and distributions happening at all times, multiplying investments in different asset classes and increased engagement with portfolio companies all produce operational complexity. Managers must treat Limited Partners fairly and hybrid funds add an additional layer to calculating fees and determining capital redemptions. There are numerous strategic and operational challenges in managing multiple sub-funds and maintaining a coherent, focussed investment thesis across them.
Soft Due Diligence in the Era of Innovation
The rise of hybrid VC funds underscores the relevance of Soft Due Diligence more than ever. As investors consider these new investment vehicles, the focus on assessing the capabilities of fund managers becomes paramount. Soft Due Diligence, in this context, involves evaluating the manager's adaptability to changing market dynamics, agility in adjusting investment strategies, and their ability to navigate liquidity events effectively.
As Limited Partners seeking to make informed investment decisions, understanding how fund managers navigate the nuances of a hybrid structure, engage with investors, and maintain transparency throughout becomes crucial. The traditional 10 year partnership used to be compared to a marriage and both the VC-LP and VC-Venture relationships are often subject to a couple analogy. In a hybrid VC fund, this relationship gets an interesting new dimension: beneficial and designed for the long-term, but - depending on the fund structure - with a lot more flexibility and a potential way out if things turn sour.
The innovation introduced by hybrid venture capital funds symbolizes the evolution of the industry and its commitment to adaptability. These funds not only challenge the conventional closed-ended model, blurring the lines between asset classes, but also emphasise the importance of catering to the preferences of modern investors.
Venture Capitalists must understand their customers – on both sides of the value chain – more than ever, customising their offer to the needs of their ventures and investor base.
As the venture capital landscape continues to transform, the principles of Soft Due Diligence remain steadfast in guiding investors, fund managers, and limited partners towards long-term partnerships that not only embrace innovation but also ensure alignment, transparency, and a shared vision for success.
Note: The content provided in this article is for informational purposes only and does not constitute financial or investment advice.