Why are overseas investment funds wanting to invest in Silicon Valley?
In recent years, private investment funds from Asia and Eastern Europe have actively joined in the hunt for attractive investment opportunities in California and across other US states. This is largely due to the fact that more than half of the existing unicorn companies in the world, are established in North America – with a large part coming out of Silicon Valley:
109 out of the 201 private companies with a business valuation above $ 1 billion around the globe are located in the United States.
The next country in terms of the number of “unicorns” is China, in which there are 45. For comparison, there are only 8 unicorns in Great Britain, and very few other countries can boast of having such success stories.
Establishing a US-based team to find top deals to invest in Silicon Valley
In the quest to find the next big unicorn, many international funds send their employees to the United States. These employees are tasked with scouting for companies with high potential and bringing deals back home. However, one must understand that it can take a couple of years to build trust in the United States and the there will be a learning curve to truly understand startup and investment ecosystem.
Foreign employees are often hampered by a significant difference in the culture and the way that negotiations take place. Moreover, it is important to learn that good opportunities do not just come to you, but are the result of hard work. The reason for that is that unlike many other countries, the United States has developed a seller’s market, not a buyer’s market. In other words, entrepreneurs can be picky given that for good projects there is plenty of capital available. A vivid proof of this is the case of David Crane, a partner of Google Ventures. He had to spend two years building relationships with Travis Kalanick, the founder of Uber, to get a chance to invest in the company when it was still valued at $ 3.4 billion (now Uber costs about 20 times more.)
Drawbacks
An huge drawback for overseas investment funds sending their employees to the United States is that they will need to pay a fixed salary, at least covering the cost of living in the US. In San Francisco, this is usually no less than $120,000-$180,000 per person per year. It is easy to calculate that only two employees and a small office space in California will cost the fund at least $ 300,000 per year. If you send more experienced colleagues, the amount can easily exceed $ 1 million. It can be expected that the US staff will eventually break into the ecosystem and generate a steady flow of good investment ideas. Once they have established themselves, it is important not to let them go – as professionals with good contacts can easily get hired by large local funds, where remuneration might be significantly above the industry average.
Establishing an external venture partner to find top deals to invest in Silicon Valley
A second common model to finding investment opportunities in the US is to cooperate with an external venture partner. A partner in such a model is an external “employee,” who is only involved in the process of finding deals. His or her remuneration can come from either a percentage of the profit from the transactions brought, from a commission per transaction, or a fixed payment. A hybrid scheme is also possible. Such partners must have the necessary technological and business expertise, as well as contacts in the region to be successful. Ideally, they also understand well the local business etiquette and can become a cost-efficient way of finding good deals.
Drawbacks
The main drawback of external venture partners is that in most cases there is a lack of involvement from such partners in the affairs of the fund. Typically, venture partners are professionals who have their main career and only look for deals in their limited free time. If a venture partner does not have a share in the fund and obligations to investors, one should not expect that it will be a priority for him or her to find deals. Among other things, venture partners usually work alone, and they do not have a team of junior staff helping them with routine duties such as screening and analyzing potential investment opportunities.>
Hiring a consulting firm to find top deals to invest in Silicon Valley
Finally, the third common option for entering the US market is to hire a consulting firm that specializes in finding companies and supporting transactions in the target region. Such consultants are in many aspects similar to investment bankers who act on the buyer’s side in an M & A transaction. The tasks that consultants solve vary from analyzing market segments and compiling a list of attractive companies to reaching the right people who can help with investing in the target company.
Usually, consultants fully undertake the search for transactions in the region or assist representatives of funds that are already deployed in the desired geography, until the latter have gained experience and begin to feel comfortable working without their support. As a rule, consultants get the bulk of the reward only if the necessary transaction is found and successfully closed. Also, after closing transactions with the help of consultants, the recognition of the fund itself is greatly enhanced. This experience increases the number of important contacts among co-investors, lawyers, bankers and other participants of the investment ecosystem that can bring new interesting deals directly to the fund.
Drawbacks
The funds should understand that if they completely delegate the function of finding deals to consultants, investors will get results, but they themselves will not understand fully how the process works. Fund representatives need to be involved in the process as deeply as possible and learn both from successful transactions and failed cases.
Proactive strategies can reap rewards of better deals
Today many foreign funds adhere to rather passive methods of deal searching. Many managers consider only those rare proposals that come to them, often from intermediaries. In many cases, these proposals might not be as interesting to investors, as they will be for participation in later investment rounds, which in certain cases no longer give a significant return on invested capital. We witnessed colleagues who invested in the “unicorn” Dropbox in April 2016, when institutional investor T. Rowe Price overestimated the company’s value with a decrease of 59% from the round in 2014.
Additionally, passive investors are forced to pay a high price for participating in transactions, which are usually structured through Special Purpose Vehicles (SPVs.) SPV managers take up to 10% of the investment amount and often up to 20% of the potential profit.
Published by Andrew Ponomar (CEO of Enter Capital)
