The Florida State Board of Administration’s (SBA) commitment to venture capital over many decades has been a contributor to the fund’s performance. Last year the team had 340 meetings and calls, reviewed 109 funds, carried out due diligence on 26 and invested in three. Successful IPOs and SPACs, plus realisations from investments made in 2013/14, have led to a standout performance.
SBA’s venture allocation is predominantly early stage, comprising a two thirds bias to seed and Series A and B funding rounds in a strategy designed to try and secure better pricing.
“This is wholly intentional. We’ve seen significant valuation increases for later stage venture backed companies,” explains John Bradley, senior investment officer for $195.5 billion SBA’s 8.2 per cent private equity portfolio under which the venture allocation falls.
It is one of the consequences of bigger pools of capital – triggered in part by new legislation introduced in the US in May 2020 that allows 401(k) funds or DC funds to invest in private equity and venture capital – flowing into venture, creating crowding in the later stage.
The hottest spot is typically two years prior to a traditional IPO where trillions of dry powder now competes with the likes of SoftBank, Tiger Global and other funds paying sky high prices lest they miss out on the next unicorn.
“Late-stage valuations are at levels we have never seen before” says Bradley.
Early-stage investment has bought challenges for Florida despite the success of the allocation. None more so than its impact on the NAV or net asset value of the portfolio, resulting in venture currently accounting for 27 per cent of the private equity allocation. On a paid in capital basis, the allocation is still well within SBA’s 10 per cent target for the asset class, but strong NAV growth has sent venture ballooning above the upper boundary of the fund’s policy range, consistently outpacing paid in commitments as a percentage of the total PE portfolio. Unable to control distributions or liquidity as companies stay private for longer – while late-stage valuations climb ever higher – SBA must ride it out.
“If you look at venture capital exposure in the portfolio on paid-in capital basis it is 12 per cent allocation but if you look at it on a NAV basis it is 27 per cent. The real increase in valuations in venture is driving that exposure on, plus the fact that distributions have been lower relative to the other asset classes like buyouts,” explains Cambridge Associates’ Sheila Ryan, who advises Florida on the allocation and reassured council members that SBA’s performance in private markets outshines most peers in its 500-strong client universe. “The numbers are very strong on an absolute and relative basis,” she said.
The NAV factor leaves Bradley and his team of eight repeatedly probing the allocation to justify the reason for such a large exposure. Current discussions centre on whether to pull back or sell in the secondary market, he says.
That alongside navigating other trends in venture like the impact of longer hold periods between investment and final distribution, currently causing him to tweak with the pacing model.
“We continue to see hold periods lengthen,” he said. “Much of the success we are seeing in 2020 is because of deals done and rounds raised back in 2013/14.”
Getting in
The other challenge inherent in early-stage venture includes fierce competition for smaller, early-stage funds. Although SBAs commitments to venture have been relatively stable over the past decade (averaging 12.4 per cent of total PE commitments since 1998) accessing early-stage investment in healthcare and biotech funds has proved particularly challenging. It’s left the portfolio with an overwhelming IT bias and only 13 per cent in healthcare and biotech.
For sure, some potential opportunities in these sectors never passed Florida’s due diligence process, but others were quickly oversubscribed given their small size.
“You are looking at $500 million in terms of fund size,” says Bradley explaining that more often than not SBA will attempt to “get in at whatever we can” and then scale up over time. But even “a $10 million allocation to a $500 million fund that has $2 billion of interest is difficult.”
The bunfight for access has seen GPs cash in, offering a swathe of late-stage and follow-on funds. A competitive backdrop which surely informs executive director and CIO Ash Williams relief that SBA hasn’t been compelled to publish the finer details of its commercial relationships with investment partners.
Commenting broadly on the fees SBA pays across the portfolio at the beginning of the meeting, he says new laws had recently threatened to force the fund to publish fee details with its asset managers. Florida’s brand and scale and the longevity of some of its relationships means it has preferential fees compared to many other investors and keeping the details secret will continue to give SBA an edge.
“We get superior terms and if you are an asset manager you don’t want to telegraph to every potential client what a great deal you are giving Florida. There is no reason for other clients to have those terms.”
Building relationships with GPs scattered around the globe is an arduous process that takes years. Last year Bradley and his team had 340 meetings and calls, reviewed 109 funds, carried out due diligence on 26 and invested in three – all of which were private equity. A process supported by a Cambridge Associates’ index which measures the effectiveness of SBA staff in selecting managers.
SPACs
Bradley and Ryan also note how SBA’s venture portfolio got a boost from the SPAC (Special Purpose Acquisition Companies) craze, which holds both pros and cons for companies.
“About 50 per cent of the appreciation in the venture capital exposures over 2020 was driven by public company appreciation,” says Ryan describing SPACs arrival on the scene as “a big change” feeding into the growth numbers in venture.
As for strategy going forward, Florida is pulling back. This means sticking with core GPs and strategies and not putting any more dollars to work.
“We prefer to go in when venture is out of favour, get larger check sizes with better GPs and negotiate fees,” Bradley concludes.
