While venture capitalists may be disrupting their own business models by pushing digitalisation, new technologies are posing an even bigger threat for their older sibling — the private equity industry. Traditionally leveraging on optimising existing structures, private equity funds are as vulnerable to new technologies as the firms they invest in.
To balance the endless onslaught from ever accelerating innovation, limited partners who traditionally invest the bulk of their money in later stage funds are increasingly passing private equity and hedge funds in favour of venture capital. This is unheard of as venture capital is usually the first to see its valves shut off because of perceived riskiness.
The case of venture capital and private equity is the classic David and Goliath juxtapose. Two of the largest private equity players, The Carlyle Group and Kohlberg Kravis Roberts, raise as much funds in a year as the entire global venture capital industry does in six months. And as in the biblical story, the real life struggle between the early-stage innovators and the incumbent industrial behemoths is about to become equally compelling as software is increasingly “eating the world.” With the help of digitalisation, David is about to get the upper hand of Goliath.
While private equity, with more than $2,5 trillion in assets, has been basking in the low interest-rate environment of the post-financial crisis era, venture capital has meanwhile built enough clout so as to start a digital snowball that is about to reach escape velocity. By pumping billions of dollars into early startups, venture capitalists have helped reimagine business landscapes from the financial industry to transportation. And “old money” is starting to take note.
In probably the boldest early-stage bet of any private equity player, a Chinese private equity firm plans to set up a fund that will invest $400 million in seed investments through a U.S. crowdfunding platform. The fund is bigger than any single Nordic venture capital fund of today. And the Chinese aren’t alone. The announcement comes just weeks after Sweden’s largest private equity firm urged private equity investors to increasingly leverage on digital innovation. Or face death.
So why is private equity scrambling for early stage? Although they are often perceived as representing the same investors, venture capital and private equity are different at the core. In simple terms, private equity may be categorised as conservative, while venture capital is liberal (see table by Victor Hwang). The inherent inertia, and the fact that they’re because of fund size forced to invest with tickets more than ten times larger than venture capitalists, is preventing private equity from effectively tapping into sustainable growth.
At the same time, foreign limited partners who invest in venture capital and private equity funds are increasingly looking at Europe to balance the overly competitive pricing landscape at home. For instance, the European venture capital arm of Fidelity recently announced that it will invest up to a fourth of its funds in the Nordics, where the price/quality balance is seen more appropriate.
As a result, Nordic startups may soon find themselves in the the middle of a perfect storm with three prevailing tailwinds, where 1) U.S. venture funds will look for value outside Silicon Valley, 2) foreign limited partners start investing in local venture capital funds and 3) private equity players start scrambling for early stage technology.
This perfect storm, even without all of its components, is making Nordic early stage investing safer relative to private equity players which are struggling with their portfolios of incumbents. While valuations at the upper end of the startup spectrum will swing violently, the steadily accelerating stream of renegade entrepreneurs will make life increasingly difficult for the current incumbents.
With this in hand, which one would you consider riskier, venture capital or private equity? Where will you find shelter when the next crisis roars? Maybe in the least expected place.