Venture capital funds are emerging as an increasingly robust and credible alternative for investors seeking attractive returns with lower risks. This is one of the conclusions of a recent event held in Madrid, which analyzed the current and future prospects of the sector in the Spanish market.
At the end of the first half of 2019, 244 funds had been launched globally, 39% less than in 2019, although, fundraising had grown by 6% over the previous year, reaching 109 billion euros. In Europe, investments in different assets exceeded 80 billion euros and fundraising exceeded 97 billion euros, of which 32 billion euros were divestments. In Spain, more than 4 billion euros were invested – 82% from international funds – with a fundraising level of 625 million euros, and diversions of 900 million euros.
With these figures, the private equity situation in Spain is encouraging. The total industry AUM reaches 27.5 billion euros, a very low volume compared to the 470 billion euros of asset management. The Spanish market continues to be one of the favorites for international funds due to its potential investment returns. As a speaker commented, Spanish companies with venture capital investments improve their results compared to counterparts: 18% more turnover, 30% more employees, and 4% more profits.
Funds in Spain
Venture capital is an investment type in which investors or Limited Partners (LPs) inject money into funds managed by General Partners (GPs). Money that participates in the capital of newly created companies that need to grow (Venture Capital), or in more developed companies that need to transform their business, expand it, grow, or other objectives (private equity).
Venture capital is a long-term investment. After a certain period in which the investment commitments are exercised and the changes in the management of the companies are formed, the divestment is carried out, generating high returns (Hurdle Rate) for the investors, as well as capital gains generated by the operations of the fund for the GPs (Carry).
Experts drew a detailed scenario from data of more than 60 venture capital funds registered in Spain. These funds applly different investment strategies (Buyout, Debt, Infrastructures, Funds of Funds, Venture) and that have completed the cycle of investment commitments between 2018-2019.
The 63% of these have a duration of 10 years, plus another 2 years of extension. 70% offer an 8% return per year (hurdle rate) to the investor. 75% distribute 20% of the capital gains (carry) to the manager. Management fees never exceed 2%, which is applied to funds up to 99 million euros in AUM. From this volume, they fall to 1.5% when the AUM reaches 1 trillion euros. Finally, 38% of the funds allow an indebtedness higher than 30% of the portfolio.
The “youth” of Venture Capital compared to other types of investment is the main factor that explains the trends affecting the sector. According to experts, assets are undergoing a natural evolution towards new products, new forms of distribution and participation, and new markets. In other words, it is maturing.
In addition, the environment of low interest rates, instability in the economy and politics, and the current volatility in the markets, accompanies this growth in assets, and thus helps them to mature. This can be seen in trends such as the internationalization of Spanish firms (which are increasing their investment outside the domestic sphere), greater diversification of strategies and products, and the transformation of the sector. First, large operators emerge as a result of concentration processes, and secondly, operators specializing in market niches as they appear.
Manager – investor relationship
Another result of the maturity of venture capital is the new trends in the manager-investor relationship: co-investment, and the participation of specialized investors and investors close to GPs in the firms. Experts have pointed out that these changes need to be explained to clients, because of the reticence they may encounter, and in order to continue adding value to investors and protect them from risks.
The high demand of venture capital investments is manifested in the high levels of dry powder (money available for new investments after divestment in other funds), which have doubled worldwide. In Spain, dry powder is still below years prior to the crisis.
A high demand that has made assets valuations more expensive. However, this does not slow down the investment activity, because the firms in the sector have consolidated their market, having high quality managers, and their investment selection processes are increasingly complex and elaborate.
Finally, the world of venture capital is joining the investment trend with socially responsible investment criteria (ESG). Currently, 14% of private equity funds have ESG policies regulated in legal documentation.
Financial Communication Manager at Proa Comunicación