Sheila Patel says it was time for the venture capital sector to “grow up” and higher rates will help do that job. VC firms need to think differently about how they invest.
Perhaps the most surprising thing about WeWork’s slide into bankruptcy is that it didn’t happen sooner.
But it’s fitting that a company with a business model so bizarre – this was a risky start-up built on sub-leasing expensive office space to other risky start-ups – collapsed in the same week Australian interest rates hit a 12-year-high.
There’s simply no way WeWork would have been valued at $US47 billion, as it was in early 2019, in today’s world of 5 per cent interest rates. But the fact it took so long to collapse reminds us that the excesses of the past decade are still seeping out of the system.
Australian superannuation funds who’ve increasingly increased their exposure to private assets would do well to remember that. But they should also heed the words of market veteran Sheila Patel, who will visit Australia next week for the Sohn Hearts & Minds conference at the Sydney Opera House next Friday.
She says this shakeout will take some time to play out. “You will see people really think about asset allocation in a different way because of the bar to which investments have to be held with the kind of yields we see in the market. And that doesn’t unwind itself in any quick way.”
Patel has had an extraordinary career. In 2021, she retired as the chair of Goldman Sachs $US2.7 trillion ($4.2 trillion) global asset management after 18 years with the firm. Now she is at the other end of capital markets as vice chair and general partner of B Capital, the venture capital firm set up by Facebook co-founder Eduardo Saverin. She is also co-chair at another VC firm, Antler.
The backdrop of rising yields has meant dramatic changes for start-up founders, who Patel says now must have both a good idea and a path to revenue and profitability. It’s harder to raise money, and valuations have fallen sharply. But that’s no bad thing, she argues.
“It forges a better founder to deal with adversity in this way. When you’re launching in this type of interest rate environment, you better be much more sure.”
But these changes are being felt across the entire sector, and venture capital firms also face a tougher fundraising environment as yields rise, valuations drop and institutional investors reassess their portfolios. Again, that’s no bad thing.
“It was time for the sector to grow up,” Patel says. VC firms are now “being held to a standard that everybody in other areas of private equity and other areas, other asset classes have long been familiar with, which is ‘what returns have you shown me lately?’”
But institutional investors will also have an eye on history, which shows that the very best VC returns are often made from investments made in tougher times.
Patel somehow found time to teach a class in derivatives at Columbia University when she was at Goldman Sachs, and she’s bringing a little of that thinking to the VC world. A derivatives trader, she explains, is trying to construct a portfolio that balances risk and reward.
This approach was arguably taken to its extreme by so-called crossover funds that sprayed cash around in late 2020 and 2021, essentially betting big winners would cover multiple losers. Patel’s goal is to swing the pendulum back to a thoughtful place.
“There hasn’t been much focus on that in the venture world, but it matters. It matters what sectors you choose, it matters what stages you invest in, and it certainly matters that you put together a fulsome enough portfolio.”
This article was originally posted by The Australian Financial Review here.
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