ARX Series 13 April 2021
The Role of Venture Capital in Modern Capital Markets
Venture Capital: What Does It Hold for the Global Capital Market of Tomorrow?Watch the Webinar
In 2020, global venture capital (VC) funding stood at US$300.5 billion, almost 7% higher than in 20191 — this increase occurred despite the pandemic that dominated the year. And with the tech sector continuing to command stock market headlines, the VC industry is increasingly in the spotlight. Particularly as many of today’s tech giants started with VC backing.
Yet, VC remains an industry still shrouded in an element of mystery, with many investors having only a vague understanding of what goes on behind the scenes. As VC as an asset class gains prominence, this is a knowledge gap that must be bridged.
To that end, we hosted a webinar titled "Venture Capital: What Does It Hold for the Global Capital Market of Tomorrow?” to explore the modern VC landscape and its role in today’s global capital markets. The panellists were Chris Shen and Eric Woo, founders of Revere VC, a Silicon Valley–based asset management firm helping bring VC investing to the broader masses.
Chris has extensive experience in Asia, having helped family offices with their investment portfolios. Meanwhile, Eric was the former head of institutional capital at AngelList, the world’s largest online VC investment platform. The session was moderated by Alan Lok, the Ddirector of Ethics Education and Professional Standards at CFA Institute Asia Pacific.
A good way to begin an exploration of the VC landscape is by providing the broader historical context.
The Venture Capital Landscape (Then versus Now)
VC investing, at least in the United States, is really nothing new. Chris — who terms it “innovation investing” — traces its roots back to the innovation wave that emerged from the post–World War II boom in North America. Even then, a good deal of private funding was involved, and the concept was to provide capital to develop and then commercialise ideas.
Yet, as Eric observes, the model has changed since then. Today, it is all about using the capital for marketing dollars to capture market share rapidly. Growth is the focus — the idea is to grow first and then maybe to figure out things like business moats a little later. As he puts it, “slow and steady wins the race does not apply to venture.”
This change has occurred in tandem with the shifting expectations of asset allocators (aka investors). They are looking at VC investing for high-return potential, causing founders to create “big vision” companies. This further supports these investors’ expectations, creating a sizeable feedback loop.
Although these investors all have the same core expectation of VC investing — potentially meteoric returns in exchange for extremely high risk — their profiles are rather diverse.
The Two Main Types of Venture Capital Investors
VC investing typically has been the purview of high-net-worth individuals (HNWIs) — who also may invest through family offices — and institutional investors. Even though the industry is gradually becoming more democratised, these two classes still form the main investor base. And both of these classes view VC quite differently.
In his experience working with Asian family offices, Chris observes that these business tycoons are looking to play the “high-risk high-reward” game so that they can leave something to support the next generation. The VC space is also exciting for them as most of them have built their own businesses. As such, they may feel that if they had this sort of backing when they started out, they could have scaled their businesses much faster.
In contrast, in the United States, VC has been an institutional asset class for at least three decades. Eric points to the famous Yale endowment fund, which has seen much of its returns come from private assets. In 1985, the fund’s allocation to buyout partnerships and VC was less than 1%. By 2001, it had reached 25%.2
As such, VC in the United States has strong validation, expertise, talent, and franchise value. The next stage of development is trying to shift the perception of VC among the non-institution crowd to that of an institutional-level view. Of course, many such investors still have questions about the entire VC model — particularly its sustainability and seemingly sky-high valuations.
Questioning the Venture Capital Model
Is VC investing akin to a game of musical chairs, in which only top-line growth matters? Is it all about finding investors willing to fund the next round? How sustainable is this? Alan poses these questions, bringing up the case of the Chinese online apartment rental platform Danke. After multiple rounds of VC financing, the company, which had gone public, saw its business crumble in late 2020 after its thin margins and debt-fuelled growth ran headfirst into the pandemic.3
Eric, however, points out that only a small percentage of VC exits are through initial public offerings (IPOs). The vast majority occur through mergers and acquisitions, typically five to seven years down the line. This makes Danke an outlier — with Eric also pointing out the media often highlight only spectacular failures as that is what captures reader interest.
On the topic of seemingly unjustifiable valuations, Eric takes what he admits is a “slightly cynical” view. He says valuations are just placeholders used to measure the company both in terms of its funding stage and the technology it is operating relative to its peers. Supply and demand dynamics also drive valuations: – the more investors want to invest in a particular company, the higher its valuations will soar. He emphasises, “such valuations are not a tradeable or mark-to-market valuation.”
It is worth remembering that VC investing follows power law returns. One successful VC investment could more than make up for 20 failed ones. As Eric puts it, it is a “game of outliers.”. Those sky-high valuations you hear about are the successful outliers. You never hear about the dozens of others that fizzle out. These power law returns also lead to the tech bias in VC investing.
Examining the Tech Bias in Venture Capital Investing
There is a common perception that most VC funding flows toward tech companies. Eric did not dispute this claim but pointed toward the nature of VC investing as being most suited to these sorts of tech-focused big-vision companies. Because VC investors are looking for high growth, they want to fund “moonshot” ideas that require a lot of time and money — not to mention a particular type of founder.
This is where VC and private equity diverge. VC is about funding a big vision, meaning the milestones are all about reaching that moon-shot and are not necessarily revenue driven. Because tech companies can rapidly scale and reap the benefits of network effects, it is natural that much of the traditional VC funding has flowed toward them.
But this could be changing.
The Evolution of Venture Capital Fund Flow
Eric points toward the rise of “emerging funds” — VC funds that focus on very early-stage investments in highly specialised niches. Many of these are run by first-time fund managers, who may come from non-software backgrounds, and thus may be more willing to fund these non-software sectors. Eric estimates there are more than a thousand such funds in the United States alone. These funds will cut the first cheque, and then the larger, more established funds can come in at a later stage.
As Eric puts it, “Whatever you imagine, in terms of a silo or slice within a particular vertical in these different industries, there is a venture capitalist, and there is an early-stage fund going after that.”
Certain catalysts are also helping this trend. The pandemic has compressed a five-year innovation cycle into one and has highlighted gaps in investment sectors, such as health and education. The fiscal stimulus in response has also led to President Biden’s ambitious infrastructure plan, which should see substantial money flowing into the sector.
The Future of Venture Capital Investing
Chris believes VC has moved from being a “nice to have” to a “must have” portfolio allocation in today's low-yield world. This also could apply to retail investors, who are slowly but surely gaining access to this increasingly democratised asset class. This democratisation is good not just for investors but for the industry. It will demand and create transparency — a positive thing in what is still considered an opaque space.
As democratisation creates more options for investors, they risk being inundated with too many choices. Eric and Chris believe this eventually will lead to more productised, curated, and customised solutions. It is not just about providing access to the VC space – but also about adding a financial and structural wrapper around these assets. That is how they are building their business at Revere VC.
All in all, they are optimistic about the future of VC investing. They point toward the “special purpose acquisition company (SPAC) craze” as evidence of investor appetite for these sorts of assets. After all, a SPAC could be thought of as a publicly listed venture fund (albeit one that can invest in only a single company). Yet, as the VC space grows, so too must education. There is a need for more experts at every level in the VC value chain, and those who are willing to put in the work also could reap the rewards.
- 2021 Future Looks Bright as Global VC Funding Soars to $300.5 Billion in the Second Biggest Year for VC Funding in a Decade 20 Jan KPMG
- 2021 Maestro of Private Equity 01 Feb IPE Magazine
- 2020 How China Apartment Rental Giant Danke Saw Its Business Crumble 08 Dec Nikkei Asia
About the Author(s)
Dr Lok is responsible for nurturing ethics trainers, producing ethics bite-size media as well as facilitating member societies to promote ethical behavior in their local capital markets. In his role, Dr Lok works with member societies to advance awareness and adoption of CFA Institute ethics and standards, as well as policy positions on ethical conduct and culture related issues. This involves outreach to local stakeholders, including the industry, financial regulator, and the public across the APAC markets. Dr Lok also manages ethics related content and events together with societies leaders as well as facilitating their outreach activities on the Asia-Pacific Research Exchange (ARX) post publication.
Dr Lok joined CFA Institute in February 2014 as the Director of Capital Markets Policy in the Standards & Advocacy Division (APAC) before moving to the role of Director, Society Advocacy Engagement (APAC) in January 2017. In that role, Dr Lok has built up close relationships with society leaders and volunteers in the APAC region. Dr Lok was also responsible for directing the establishment of the Asia-Pacific Research Exchange (ARX). Over the years, he co-authored two monographs on portfolio pumping and market manipulation, submitted numerous regulatory consultation papers, written many blogs & articles and supported the Singapore Society in their Industry Research series in the Singapore Business Times.
During the decade prior to joining CFA Institute, Dr Lok was the senior investment manager of a Chinese solar-energy conglomerate and worked as both a buy and sell-side research analyst in Singapore. Dr Lok also served as the Adjunct head of two modules in Nanyang Technological University (南阳理工学院) as well as the module leaders for various universities in Hong Kong SAR, Mainland China, and Singapore.
Dr Lok graduated with a degree in Electrical & Electronic Engineering from the Nanyang Technological University in Singapore in 2003. Subsequently, he went on to read his MBA at the University of Manchester in 2013. He obtained the FRM certification from the Global Association of Risk Professionals in 2007 and was subsequently awarded the CFA certification from the CFA Institute in 2008. Dr Lok was recently awarded a doctorate degree from the University of Middlesex, London in 2021. His latest publication was a co-authorship with ACCA entitled “21 Sector Analysis: A Questioning Framework for Investors”.
Chris Shen (沈偉士) is the co-founder of Revere VC, where he jointly oversees all investments, asset management, strategic initiatives and operational activities. Chris is also a managing partner of all Revere-managed fund products.
Chris also currently serves on the advisory boards of tech companies FiscalNote, Booqed and Zectr, and is a venture partner with BridgeWood Alternatives and GPO Fund. Chris is also a Founding Partner (non-executive) of West 22nd Capital Advisers, a Hong Kong-based single family office and investment firm that is licensed by the Securities & Futures Commission of Hong Kong (SFC). Among other roles, Chris established the firm’s operations, served on the investment committee, and led venture capital and external asset manager investments. Before that, he was a special counsel with the global law firm Baker McKenzie, focusing on corporate finance and fund formation matters in the APAC region.
Chris is a Type 1/4/9 responsible officer under the SFC, is admitted to practice law in the State of Texas, and speaks fluent Mandarin. He also serves on the board of directors of the Museum of Chinese Americans (MOCA) NYC and is active with the Association of Asian American Investment Managers (AAAIM) and The Investment Diversity Exchange (TIDE). A native Houstonian, Chris lived and worked in Greater China (Beijing, Taipei and Hong Kong) from 2006 to 2019, and now splits his time between Silicon Valley and Hong Kong.
Eric (烏家隆）is the co-founder of Revere VC, where he jointly oversees all investments, asset management, strategic initiatives and operational activities. Eric is also a managing partner of all Revere-managed fund products.
Eric was formerly Head of Institutional Capital at AngelList, the world's largest online venture capital investment platform that manages US$2.5B in assets and has produced 77 "unicorn" companies. At AngelList, Eric worked closely with family offices to curate early-stage fund and deal opportunities. He also developed systematic and data-driven strategies for institutional investors.
Over the last 11 years, Eric has helped invest over US$160 million as a limited partner in venture funds and as a direct co-investor. Notably, he played a key role in establishing the emerging manager investment programs at Top Tier Capital and Northgate Capital, organizations that collectively have more than $10B in AUM.
Before his venture career, Eric worked in pricing and risk management for a large insurance company and financial guarantor. He also has experience in online marketing and private markets research.
Eric graduated with a B.S. degree in Mechanical Engineering from UC Berkeley and has been a CFA charter holder since 2004.