Last year, VCs watched nervously as hedge funds moved more aggressively into venture investing, taking ever-larger stakes in later stage deals.
Now, with overall venture investment levels down and as U.S. economic growth slows, some VCs are more concerned about hedge fund capital drying up.
“The pessimistic case is these investors will pull back to their niche,” says Erik Straser, partner at
Straser, who focuses on cleantech, says that because the businesses he backs tend to be capital-intensive, early stage investors rely on alternative sources, such as hedge funds and large asset managers, to close large, later stage rounds. With exits scarce (just five venture-backed companies went public in the U.S. in the first quarter, and M&A levels were at their lowest in five years), later stage fund-raising has become more crucial for companies looking to survive until conditions improve.
So far, hedge fund investors are still making venture investments, albeit at a slower pace.
Another active player, hedge fund manager
This year, however, OchZif hasn’t been actively adding venture assets. It’s made just one small investment, part of a $3 million round for greeting card company ArrowEye Solutions, according to Thomson Financial.
Artis scored again last year with the IPO of Aruba Networks (Nasdaq: ARUN). Meanwhile, Artis invested in six private companies during 2007.
So far, Artis, which invested in six private companies in 2007, has done only one such investment this year.
D.E. Shaw Group, a $35 billion hedge fund operator, has also kept up the pace. The company made about a dozen venture capital investments last year, and tacked on another four in the first quarter of 2008. Another sometime venture investor, The Galleon Group, a $5 billion New York-based hedge fund focused on information technology stocks, meanwhile, added another two venture investments in the first quarter.
Hedge funds’ cautious approach to venture comes amid a down period for public market investments. As of last week, an index of hedge funds tracked by Hedge Fund Research was down 3% year-to-date.
Moreover, not all hedge fund forays in the VC asset class have played out well. Among the most well known misfires was Pay by Touch, a San Francisco-based biometric technology startup with a reported $300 million in funding from hedge funds and other investors, including Mobius Venture Capital. The company filed Chapter 11 bankruptcy in December.
But with public market volatility levels running high, hedge funds may see some benefit to bulking up on venture assets, says Bill Burnham, a former Mobius Venture Capital investor and founder of small hedge fund
“By adding assets to their portfolios that do not re-price every day, hedge funds can lower the reported volatility of their overall fund,” he says, adding that he believes hedge fund VC investment levels will increase in 2008.