Hedge funds have long been the funambulists and contortionists of the circus that we call the financial sector. It was not so long ago that hedge funds pushed into real estate, purchasing thousands of single family homes in selected markets. Recently, the hedge fund industry has, once again, revealed its nimble nature by investing in entrepreneurial enterprises.
Does Venture Capital Have a Border Issue?
Not yet, but any imagined boundary between venture capital and hedge funds is blurring. While hedge funds have dabbled in start-up funding for the past decade or more, the practice seems to be gaining real momentum.
One significant example of this trend lies with Coatue Management’s $50 million funding round for Snapchat. Coatue also invested in the mobile travel start-up Hotel Tonite, and Box, a cloud storage and file sharing start-up. To the chagrin of venture capitalists, this San Francisco-based hedge fund is only one of several instances of this phenomenon.
Valiant Capital Partners and Maverick Capital are additional firms to have crossed over. Valiant Capital Partners invested in Dropbox, Evernote and Pinterest, while Maverick made seed investments in Zenefits and Estimote, establishing the fact that hedge funds are true players.
While venture capitalists are understandably intimidated, the facts would indicate they have little to fear from hedge funds. Venture capital has extended funding to the tune of $30 billion in the first three quarters of 2014, exceeding its funding levels for all of 2013.
Good for Entrepreneurs But What About the Hedge Fund Firms?
Cash for equity investments offer hedge fund firms extraordinary opportunities for colossal profits. Consider for a moment the gains reaped from Instagram’s sale to Facebook for $1 billion.
Although the tech sector has been held in some disregard by hedge funds, as a result of the dot com bubble burst in 2000, the teeter is starting to totter in their favor of late. A major contributing factor is that most tech companies are demonstrating greater restraint than in the past, waiting for revenue run rates in excess of $100 million and establishing a track record of global growth before going public—think Facebook and Twitter.
This level of patience has reduced the perceived level of risk for many hedge funds. More to the point, hedge funds are not the doting, nurturing and supportive investor that many early stage companies require. This makes hedge funds palatable investors for well-grounded companies in the growth stage.
Hedge Funds Offer Greater Flexibility
While hedge funds take a back-seat to venture capital in terms of support, they are more flexible in what they deem an acceptable return on investment. VCs, in the main, seek a much higher rate of return than their hedge fund counterparts.
As a result, hedge funds are carving out a niche by offering higher valuations and accepting lower returns than their venture capital firms are typically willing to accept. Let’s be clear, an investment that brings returns into the double-digits is very attractive to hedge funds accustomed to gains in single digits.
The real winners in this hedge fund intrusion are the tech start-ups and their founders. Fresh sources of capital are always welcome and hedge funds, at least for the moment, seem to be that source.
