Solving the ‘living dead’ issue in VC funds

Anthony Silver (pictured) and Andrew Salter of Enhanced Venture Capital Recovery discuss how to dispose of non-core assets lingering in venture capital funds.

Limited partners and general partners both recognise that in venture capital, 80 percent of returns are generated by a mere fifth of the assets. Despite this ratio, a surprisingly low 10 to 15 percent of VC investments are written off due to corporate failure.

What is left in between the two extremes of hurdle heroes – investments that are going to make spectacular returns – and the dead – investments that don’t survive – forms the major rump of a general partner’s portfolio. There is as yet no industry jargon to describe what we call the “walking dead”. These are not to be confused with zombie funds which have run out of dry powder.

The walking dead present a real problem to the VC industry and one that becomes bigger every year. GPs generally take on a duty of care when originally investing, so managing these assets costs time and effort for no return.

There is also a heavy opportunity cost as managing them takes a big cut out of the number of hurdle heroes the firm’s executives can manage. We estimate that such assets account for more than 90 percent of assets by volume.

Ideally, what VC managers should do is discover, invest and guide the successful companies to a remunerative exit. What they actually end up doing is managing a portfolio of living dead assets with the odd hurdle hero.

Friction points

LPs are increasingly questioning the 2 percent management fee, and VC managers are especially vulnerable when looking to extend the life of a fund as LPs are disinclined to continue to pay the management fees. In this situation, LPs increasingly look to secondaries funds for liquidity.

Secondaries deal volume has grown at an annual compound rate of almost 27 percent over the last six years, hitting almost $50 billion last year according to Setter Capital. This puts pressure on primary funds to become more efficient as LPs now have a real choice and secondaries funds have better metrics than primary funds.

Meanwhile, for GPs, disposing of assets results in a pro-rata reduction in the management charge and their income, creating a dilemma.

Individual sales of non-core assets

Both VC and private equity funds generate a pile of non-core assets, which are often a collection of minority interests in companies with no share liquidity. The values are too low or too diverse to attract the interest of intermediaries, and while other competitors within the sector may express an interest in appraising the portfolio, in reality, few if any have the appetite to acquire stakes at more than 5 percent of book value.

Such amounts are too small to justify the use of limited management resources. Direct secondaries funds acquire portfolios for what they consider to be prime focus assets, but often end up with non-core assets themselves.

Because disposal of non-core assets requires marketing outside the GP’s comfort zone or resource capabilities, and it will never move the needle, it makes sense to outsource the problem on a low-cost basis, especially when by doing so the uplift is measured in multiples.

To get the best price for these non-core assets, they need to be marketed to family offices, high net worth individuals and private banks, all of whom have an appetite for these opportunities. The assets need to be marketed individually rather than sold as a portfolio and the marketing and sale process needs to be managed.

Enhanced Venture Capital Recovery LLP provides marketing and management services for underperforming assets to promote portfolio efficiencies for GPs.