Hedge funds and other nontraditional sponsors are changing terms for founders and GPs.
The U.S. is minting more unicorns than ever before. According to data from CB Insights, a new unicorn was created every day in 2021 – a new record. That data point speaks to not only the level of innovation happening within growth industries, but also the level of capital investors are willing to put to work to support these companies.
Much of that money is coming from nontraditional sponsors. Firms including Tiger Global Management, Coatue Management, and others are beating out traditional venture capital and growth equity firms in both number of deals done and overall ticket size. According to CB Insights, Tiger Global made 350 investments in 2021, a number rivaled only by startup accelerator Y Combinator which launches groups of startups biannually for its early stage program.
The impact of nontraditional firms is significant and is already being felt throughout the industry. Critics of these firms (typically, traditional venture and growth equity sponsors) argue that these firms overprice deals, lack specialized expertise, and aren’t doing enough diligence.
Industry analysts note that whether or not the criticisms prove to be correct, the early result is that founders may benefit. Traditional sponsors are softening terms to lure founders. Sponsors of all types are also doing more in-rounds to keep the best companies on the books for longer.
So what makes these firms stand out? The approach of crossover firms tends to be different from traditional VCs and their investing style shows that diversification within the portfolio is the big bet they’re all willing to make.
Tigers run the enchanted forest
By mid-2021, Tiger Global had already out invested every other firm in the venture capital/growth equity space and there was no indication that they would slow down. Tiger Global is known for having a very aggressive investment approach – the deal team moves quickly if it is interested in a deal, often opting for a very fast diligence process and following it with a bid that is usually well over what others are willing to pay. That cash also comes with few strings, Tiger typically doesn’t take board seats or push for a specific agenda.
Tiger’s approach harkens back to its hedge fund roots with a focus on total return. The firm raises large funds – its most recent venture/growth fund had a first close at $8.8 billion in October, according to Bloomberg data. As a result, Tiger either needs to make several medium-size investments or a few very large investments. It’s opted for diversity. Because the initial investments are smaller and spread across a larger number of companies, the diversification can mitigate the impact of one or two bad bets. Within the fund then, the per-investment return may be smaller but the total return of a given vintage is larger. Tiger has an IRR of approximately 27% for its growth vehicles, according to Bloomberg data. The strategy is different from venture investors that are typically looking for a lower price at entry so there is less risk of a lower exit multiple. Tiger’s investors, however, might be more willing to go along with it because they’re used to consistent double-digit total return resulting from maximum investment and low cash on hand in the hedge fund.
The firm reportedly has also significantly invested in data and analytics so it can monitor the performance of potential targets as well as its own portfolio companies. These monitoring capabilities give it significant visibility into the startup ecosystem and help it act early on new deals or material changes within its funds. Making early trades based on an information edge is a classic hedge fund move.
Tiger Cub Coatue Management uses a similar approach. Coatue styles itself as a multi-strategy investment firm which allows it to target both public and private companies across its investment vehicles. Like Tiger Global, it also invests significantly in its data and analytics capabilities – approximately $35 million annually, according to data from The Information.
So far, the focus on data has worked. Coatue put $15.9 billion to work in 2021 alone, making it the third-largest investor all year according to data from CB Insights. Like Tiger, Coatue is aggressive and diversified in its approach. Its highest-profile bets which include TikTok parent-company ByteDance, Snap, and Spotify have all paid off. Coatue’s third growth fund posted an IRR of 47% according to The Information.
Unlike Tiger, Coatue will take board seats and has a more hands-on approach with management but that may not scare off founders. The open-ended nature of its investment strategy also means that Coatue invests as early as seed and as late as pre-IPO, and can hold on to positions post-IPO. For a founder, this can mean a much more streamlined financing process if the lead sponsor remains the same somewhat indefinitely.
By betting big on diversification and information asymmetry, Tiger and Coatue treat venture and growth investing like any other asset class and they aren’t tied to the conventions and norms that traditional sponsors have adopted over the years. The earliest impact of this approach has been a loosening of terms from traditional sponsors, but if the exit environment remains positive, traditional sponsors may have to change more about their approach to stay competitive. This may mean writing bigger checks initially or relying more on in-rounds to retain control.
Managing the exit
2021 wasn’t only about minting new unicorns at a record pace. The SPAC frenzy coupled with renewed interest in direct listings and IPOs opened the door for other nontraditional roles to expand their footprint in venture and growth equity.
Dragoneer and Altimeter Capital were two such firms. Multistrategy firm Dragoneer, has raised three SPACs since the boom began in 2020, making it part of a small group of repeat issuers with an institutional finance pedigree. Altimeter has also emerged as a repeat issuer and a SPAC liquidity provider in the PIPE market. The involvement of these firms in the SPAC market is notable because now, nontraditional sponsors are involved in all aspects of early-stage to growth to exit.
Early indications are it’s an attractive strategy to both startups and investors. Both firms are in market with new growth funds, Dragoneer is reportedly targeting $2.5 billion and Altimeter has targeted $1 billion, according to Bloomberg. Dragoneer’s track record includes investments in several unicorns including Airbnb and Uber. Altimeter was an early investor in financial-technology firm Plaid.
The combination of a broad investment remit coupled with a positive track record in the SPAC market could make firms like Dragoneer and Altimeter harder to compete with. The SPAC craze has cooled off, but that means that the activity that remains is more likely to be dominated by repeat issuers who have shown they can deliver. Both firms fit this mold.
Going forward, traditional sponsors may have to work harder to differentiate themselves from the growing impact of nontraditional investors that want to be fully invested from seed to exit regardless of price. By treating venture and growth equity as just another set of asset classes, these firms are challenging many of the norms within venture and growth equity and in part they are succeeding. Traditional sponsors may be tempted to alter their approach to get in on the next big unicorn, however, the jury is still out whether the Tigers of the world will succeed in the long run.
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