Not a day goes by without a new European startup announcing a large fundraising round co-led by US hedge fund Tiger Global. Some say it’s a radical change of approach in the venture capital industry, while others suggest that it’s a fad. But how can we explain the rise of Tiger Global in the VC landscape? And what difference will it make from a European perspective?
In truth, it was only a matter of time before hedge fund managers turned their attention to tech startups. By definition, hedge funds (or rather “alternative asset management firms”) have the most flexible approach to allocating capital across asset classes, and those who manage them are constantly chasing the highest returns possible. Therefore in a world that is becoming more digital by the day, hedge funds had to set their eyes on tech at some point.
The issue with tech startups and tech companies is that relatively few of them are listed. This arguably is a challenge for hedge funds, which are used to making bets on public markets where they enjoy abundant information, a broad range of potential targets and liquidity.
Follow the (VC) money
The approach that Tiger Global has embraced to deploy capital in tech is best understood through this lens.
It has to renounce the liquidity because we’re talking about companies that are still mostly private; but it can still diversify with a large portfolio and use the information that’s available to make fast and sound decisions. In this case, the information is not the detailed figures that you can find in a public company’s quarterly report or the alternative data sets you can buy from a broker (the occupancy rate of supermarket parking lots as measured by satellite imagery is a classic example), but rather the information revealed by what tier-1 VC firms are investing in. As soon as a founding team enters advanced discussion with one of these firms, it is time for Tiger Global to use that information (which they typically learn from the founders themselves), step in and make an offer.
If following tier-1 VC firms is so easy, why isn’t everyone with billions of dollars under management doing it?
If following tier-1 VC firms is so easy, why isn’t everyone with billions of dollars under management doing it? For a simple reason: these VC firms don’t like to share, and when they decide to back a company, they usually don’t let anyone else participate in the round. The trick that Tiger Global is pulling to get its foot in the door is that it's offering a better price.
Founders that have passed the Series A stage are eager to raise as much money as possible at a high valuation, and they don’t need a VC firm’s hands-on support as much as at the earlier stages. Traditional VC firms — including the most sought after — are forced to match the higher price offered by Tiger Global if they want to keep a slice of the round.
First came SoftBank
Before Tiger Global, SoftBank had a similar approach, but blunders like the infamous WeWork deal (and, maybe, the fact that it's from Japan and led by a very unconventional executive, Masayoshi Son) made it easy for VC firms to castigate SoftBank and keep it out of many good deals.
On the other hand, the fact that Tiger Global comes from the most prestigious corner of the US financial services industry (its founder, Chase Coleman III, is one of the so-called “Tiger Cubs” — fund managers who started their careers with Julian Robertson’s legendary Tiger Management) makes it more difficult to depict it as the clueless intruder. (And, for the record, SoftBank just announced its most profitable year ever, so it was premature to ever write it off too.)
No such approach would be possible without the current context of cheap capital and high valuations.
No such approach would be possible, however, without the current context of cheap capital and high valuations. Tiger Global is on firm ground because it's following the macro trend of software eating the world and tech entrepreneurship becoming a global phenomenon. But, having raised $6bn+ for its latest fund, it's also relying on what is only a passing phase, enabled by the macroeconomic context and the fiscal and monetary profligacy of governments and central banks around the world.
The question that everyone’s asking these days is: what will happen to all the companies that have taken Tiger Global’s money when the latter trend reverses and everything goes back to normal — growth rates, cost of capital, valuations, governance, returns? Maybe they’ll have put that money to good use to gain market share and wipe out their competitors. But it could also end badly for some of them.
What happens when things go back to normal?
A notable difference between the world of VC and the world of hedge funds is that hedge fund managers have no problem changing their mind in an instant and redeploying capital accordingly. VCs, on the other hand, are not very good at changing their mind once capital has been committed, in no small part because redeploying is difficult in the illiquid asset class that is venture capital.
How would the hedge fund approach translate in a VC context? Once it changes its mind, Tiger Global could simply write off the struggling companies in its portfolio. Or it could take an activist approach and step in, taking a board seat and forcing a radical restructuring or consolidation of the struggling business, just like any other activist investor. Or it could then organise a sell-off at a hard discount on the secondary market, getting rid of the distressed assets, recouping part of its losses and leaving the task of cleaning house to other, more hands-on investors. (Turnaround and building up specialists taking control might become a force that tech startups must reckon with in the future.)
We in Europe can only applaud Tiger Global’s bursting into our most promising companies’ cap tables.
In any case, we in Europe can only applaud Tiger Global’s bursting into our most promising companies’ cap tables. As a rule of thumb, in any entrepreneurial ecosystem there are always more promising companies in need of capital than there are investors willing to deploy it. An ecosystem that’s not mature can only grow if it attracts unconventional investors willing to bridge the gap: whether local investors that are not technically VCs, such as corporations or governments, or foreign investors that are able to spot opportunities and make money before the locals.
If history is any guide, none of these unconventional investors are here to stay. At some point, the ecosystem matures and gives birth to its own strong VC industry, one that is able to support local businesses from seed to late stage without having to include investors from the outside.
And so this is my interpretation of what’s happening at the moment: Tiger Global is making the most the nascent European VC industry to make as many bets as possible beyond the US market, using the information local firms reveal and following their lead. At some point, however, after the current bubbly trend has reversed, European VCs will likely step up and take over from Tiger Global.
It’s probable that the hedge fund will have made a lot of money in the meantime. We should simply hope that not too many companies and VC firms are damaged by excessive valuations and the many down rounds that are likely to follow in the wake of the shift.
Nicolas Colin is cofounder of VC firm The Family. He writes a regular column for Sifted.