Many of the largest venture capital firms are structured as limited partnerships with funds that are not available to retail investors. Investors in limited partnerships, typically strategic investors, high net worth individuals and family offices, are placing a bet that the venture capital firm’s fund will find, capitalize, and exit investments that will outperform what those investors could have made in the public markets or in other asset classes.
While most large venture capital firms are typically only available to select investors, publicly traded venture capital funds are few and far between. Canopy Rivers is the only publicly traded cannabis venture capital firm, and the only venture capital firm trading on the Toronto Stock Exchange. While this makes us a good starting point for investors looking for exposure to private, up-and-coming companies, it also means there are few peers to which we can draw comparisons, and little familiarity with how long it typically takes venture capital firms to produce returns.
Explaining the traditional venture capital timeline has consistently been one of the trickiest parts about being a publicly traded VC firm. Fairly, we are evaluated on a quarter-by-quarter basis, like other public companies, and investors understandably want to see progress between those quarters. At the very least, they want to hear how a company plans to achieve growth — and profits — in the coming quarters. But this quarter-to-quarter measurement is difficult to square when venture capital is about waiting for a significant exit opportunity rather than pushing for exits at regularly scheduled intervals.
The goal behind making venture capital investments is to expect a 10x return on invested capital over the investment horizon. Achieving this potential return can take years. Statista reports that the average timeline from initial venture capital investment to exit in the U.S. was 6.3 years in 2019. While this is down from 7.4 years in 2017, it is roughly consistent with previous years in that no year since 2007 has seen an average exit timeline of less than six years.
This timeline has increased dramatically since venture capital started, having its biggest moments as an industry during the late-1990s and early-2000s tech bubble. When the tech bubble peaked in 2000, the average venture capital exit timeline was hovering around three years, and dipped to two years in 2001. Capitalizing on the salivating demand for tech stocks, companies raced to the public markets. Amazon was founded in 1994 and went public in 1997; Netscape was private for only a year before going public in 1995. While Amazon survived to become a global behemoth, the short venture capital runways and tsunami of IPOs that led to the dot-com bubble bursting arguably changed venture capital for the better.
Going public too early arguably caused significant issues for many of the companies that were aiming to take advantage of the hype surrounding the tech sector. With their businesses now accountable to public investors who wanted to see sharp growth and returns, many tech firms saw their business models collapse under the pressure. The rush to go public came at the expense of fundamentals.
Both management teams and venture capitalists recognized this and since then have adopted a longer timeline that stresses sustained growth and customer and revenue generation over profits. Companies want more time to achieve stable profits, thereby raising their valuations when it comes time for an acquisition or IPO.
Everyone. The natural process of M&A and going public, when it’s organic and done over a longer period of time, is better for both companies and investors. Venture capitalists obtain better multiples on their investment, albeit over a longer timeline, and businesses are able to mature on their own terms. They are more likely to be able to effectively carve out a defensible moat, focusing on scale, customer acquisition, and revenue generation.
Companies that stay private are more likely to have time to solve lingering issues around their business, especially in industries that evolve as fast as cannabis and tech. Better for them to do this while private than public, else they face some of the scrutiny companies like Snap and WeWork — which never actually went public — faced during their highly publicized IPO processes.
The one audience unaccounted for in this new venture capital model is the investors in a public VC firm. With an indirect stake in these private companies, they understandably want to see immediate paths to profit and hear quarterly plans from their VC on how they will monetize investments through IPO or M&A. But any venture capital firm —public or private— who plays by the rules of the early 2000s will find their reputation quickly eroded. Deal flow will not come to any company whose objective is to force their investees into an untimely acquisition or IPO before they are ready.
And while this might be counterintuitive to most retail investors, we think they’re better off for it, too. Pushing companies into mergers, acquisitions, or IPOs to satisfy quarterly earnings reports not only builds a lasting negative reputation, but it also limits the value of the companies involved. Any of these events happening prematurely means that the VC is capping their value. Unless there’s a desperate need for cash, it’s hard to think of a reason why this is preferable to waiting for better returns, even if that could take years.
It’s also worth addressing the liquidity question. Venture capital firms often see massive cash outflow before they start to see some of it coming back to them. Investors rightfully want to know that their public venture capital investment won’t run out of cash. That’s why it’s important for venture capital firms to have varying stages of investments with varying structures, some of which may produce short-term cash flows.
While public market investors look for companies to deliver returns quickly and consistently, venture capital is a patient process that takes years to deliver cash flows. Investors want to see quicker and more consistent returns in line with other successful public companies. Success in venture capital, though, comes in waves. This might take time, but the outcome is worth the wait.
This is not an offer to sell or a recommendation to trade in any securities. This information is provided as of the date hereof. This document contains data obtained from third parties that Canopy Rivers has not independently verified. This document also contains forward-looking information within the meaning of Canadian securities law, which is based on certain assumptions. While management believes these assumptions are reasonable based on information available as of the current date, they may prove to be incorrect. Many assumptions are based on factors outside of Canopy Rivers’ control and actual results may differ materially from current expectations. Forward-looking information involves risks, including, but not limited to, the risk factors set out in Canopy Rivers’ most recent Management’s Discussion and Analysis and Annual Information Form. You should not place undue reliance on forward-looking information. Except as required by applicable law, Canopy Rivers assumes no obligation to update or revise any forward-looking information to reflect new events or circumstances.
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