To VC or to PE? Questions, questions, questions! Read the newsletter in your browser.

12 February 2023

Next Wave: Should VC become PE?

Questions, questions, questions? | Photo: Javier Allegue Barros via Unsplash

For every action, there is an equal and opposite reaction. This is the equal and opposite side of last week's argument for venture capital to copy PE.


Last week I suggested that venture capital might benefit from taking on some characteristics of private equity in order to improve exit chances. From the feedback I received, it is clear that many investors are thinking in this direction.

Ola Brown, founding partner at Healthcare Capital Africa had written a note on LinkedIn outlining venture capital’s shift towards a private equity approach to evaluating investments. “I do believe that the asset class is evolving for legal reasons as well to improve its returns/performance. I outlined a greater and more objective focus on revenue/potential revenue as a basis for valuations, deeper and more extensive due diligence and improved corporate governance,” she wrote.

Managing partner at Lateral Frontiers Capital, Rob Eloff, agrees. In 5 places to escape to this investment winter, he wrote “The reset in valuations and macroeconomic outlook has challenged us to reflect on headwinds and opportunities for innovation.” He goes on to list five thematic investment destinations that African investors may want to take a closer look at in 2023. In discussing his third theme, “Private equity in overdrive, Eloff points out that growth private equity activity in the US has “ratcheted up over the past 6 months with strategies to take bloated moderate growers private or to recapitalize strong technology stacks that require business model pivots”.

Managing partner at Lateral Frontiers Capital, Rob Eloff, agrees. In 5 places to escape to this investment winter, he wrote “The reset in valuations and macroeconomic outlook has challenged us to reflect on headwinds and opportunities for innovation.” He goes on to list five thematic investment destinations that African investors may want to take a closer look at in 2023. In discussing his third theme, “Private equity in overdrive, Eloff points out that growth private equity activity in the US has “ratcheted up over the past 6 months with strategies to take bloated moderate growers private or to recapitalize strong technology stacks that require business model pivots”.

Eloff expects this type of increased activity from private equity firms. Indeed the recently concluded $400 million funding of Egypt’s MNT Halan involved a $260 million secondary transaction that saw a group of private equity investors exchanging stakes in the company at a reported $1 billion valuation, post-money. Consequently, the Lateral Frontiers boss makes the case for leading US PE firms to look towards Africa for deals.

A selection of private equity firms that have crossed into venture capital, directly or indirectly. | Chart by Mobolaji Adebayo – TechCabal Insights

Personally, I don’t expect much in the way of PE firms buying African tech companies. Private equity is itself from certified good health coming out of the last two years of the reign of cheap money. There are a lot of unrealised gains and unhealthy leverage that may prompt LP withdrawals. We’ve seen some of this hit larger firms like Blackstone. This aside, PE firms become interested in deals that they can conservatively estimate upwards of 20% internal rates of return (IRR). One important component of PE dealing is the availability of cheap leverage. That door is not very open and with it, IRRs of greater than 20% in the vast majority of overpriced deals now in the market.

African venture capital will need to save itself. Hence my proposal that we borrow some PE methodology not necessarily PE methods.

But not everyone agrees.



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“There is a great gulf fixed betwixt us”

Following my piece last week, I had a conversation with Ido Sum, a partner at TLcom, about this very question of how much, if ever, venture capital can borrow from private equity. Sum doesn’t think there is much to borrow. And the fundamental difference, he explained, lies in the PE approach before even considering investment opportunities.

“These are two extremely different schools of thought. And have been so for a reason. They're looking for businesses at different times in their life, with different risk-and-reward balance,” he explains, referring to how venture capital seeks to support unproven business innovation whereas private equity focuses on “turn-around” investing in established but poorly performing companies.

“If you look at a ten-company portfolio of a VC fund, you assume that one or two will hit it out of the park and return the fund a couple of times over. Another three, four or five will be mediocre, [returning] between two, three or four times the Investment. And a bunch will be between 0 and 1 and not return capital, or will return something that is insignificant. When you run the numbers, you assume that all of this together will bring you to the proverbial 3x,” says Sum.

Sum does not believe that doing more due diligence, and instituting better corporate governance means VC is becoming more like private equity. LPs may be shaken by the recent losses, but Sum points out venture capital unlike private equity is long 10+2-year game, a point that I agree we easily forget.