UK chancellor Jeremy Hunt’s Mansion House speech was welcomed by many in the British tech ecosystem as a sign that pension funds will finally start allocating capital to private equity and venture capital.
And so it should have been. These are natural asset classes to be held in pensions: long term, to match long liabilities, and with strong growth potential. Pension fund beneficiaries should be pleased with the opportunity to deploy capital into true growth opportunities rather than the recycling of existing financial assets that fails to contribute to the wider economy.
Likewise, the VC industry should welcome the potential for additional capital from new and evergreen sources. I couldn’t be more excited about having institutional capital deployed at scale in early-stage businesses.
But let’s be clear. It’s not that easy, and there are some major questions that need to be answered.
1/ Can the VC industry adapt technically to meet pension fund requirements? Pension funds require transparency on portfolio valuations and on fees, among a lot else. Work needs to be done so that VC firms meet these pension fund requirements.
2/ Can VC firms professionalise enough to make it attractive for pension funds to invest? VC is a bit of a cottage industry at the moment. The type of due diligence on investment processes, benchmarking and outcome measurements that pension funds will require may come as a shock to some VC managers.
3/ Can the VC asset class demonstrate sustainable alpha generation? Frankly, historical VC returns have been mediocre and widely dispersed between the few outperformers and a relatively long tail of okay and poor. The majority of VCs don’t outperform public markets. Few VCs can prove that they have the ability to achieve repeatable returns. It’s one thing to allow pension funds to invest; quite another to make them want to.
4/ Is the industry big enough for pension funds? We’ve seen clear evidence that too much money chasing too few VC deals results in value inflation and skewed outcomes. SoftBank’s experience is a good example. VC is a $250bn a year market globally, but this is quite heavily skewed by very large investments, mainly in the US, into a relatively small number of deals.
5/ And finally, can individual VC firms scale up to make it worthwhile for a pension fund to invest? Most UK-based VC funds are small — £20m-50m — and yet pension funds need to write £100m cheques to maximise efficiency, and typically don’t want to be the major investor in a particular asset. How many billion-pound VC funds are there, or could there be? The way VC has tended to scale in the past is by doing the same number of larger deals, rather than more deals of the same size. The traditional VC model doesn’t scale, as it’s so dependent on intensive human processes. Can this change?
Pension fund allocation to the VC asset class is a much bigger challenge than might be obvious. It requires fundamental changes to processes, performance, business models and structures. It’s the kind of change that hasn’t been achieved in its 65-year history.
Our data shows that pre-seed and seed stage investment could easily grow 5x without compromising quality
So how can we make that change possible? For my money, it’s ensuring we get it right from the start. We must build the strongest and broadest possible base of well-funded pre-seed and seed-stage businesses. This base layer of the investment pyramid will provide the scale required at Series A, B and beyond — the happiest hunting grounds for VCs — and the scale required for pension funds to be able to invest.
Our data shows that pre-seed and seed-stage investment could easily grow 5x without compromising quality. What it will require is for us to search in all corners of the entrepreneurial landscape to identify the underserved businesses and founders who don’t fit the current VC mould or struggle to be heard.
Just imagine if we could get that right. 5x more companies moving up the pyramid, meeting a wall of pension fund money, eliminating the earlier and later-stage funding gaps…
… and making a truly staggering contribution to job creation, social mobility and our economy.
