Venture Capital’s Sovereign Wealth Crisis Cometh

When a country has blood on its hands, everything it touches gets a little dirty.

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Allegedly at the behest of Crown Prince Mohammed bin Salman, a 15-person Saudi hit squad illegally detained, tortured, murdered, dismembered, and attempted to dissolve the remains of dissident and journalist Jamal Khashoggi in Turkey this past October.

That act catalyzed a sovereign wealth crisis in venture capital and private equity that I expect to play itself out over the course of next year.

Of course, we don’t know how it’s all going to shake out, but here are some predictions for 2019:

  • The Positive: Investors, founders, and the general public will continue to make associations between state-backed capital with state-sanctioned actions that run counter to their political and ethical values.
  • The Cynical: No single state action, however odious, will make the entire market turn away capital from a sufficiently large sovereign wealth fund.
  • The Unlikely: U.S.-led sanctions on Saudi Arabia, either under the Magnitsky Act or other law, would severely damage the late-stage funding market. However, given president Trump’s financial entanglements with the Saudi government and the chummy relationship between the U.S. president’s son-in-law Jared Kushner and the crown prince, such a sanctions regime is unlikely under the current administration.

Let’s unpack this a bit.

What do founders do with the money they’ve raised from sovereign wealth funds represented by characters more unsavory than previously thought? What are you going to do, give the money back? Whatever hasn’t been spent has already been allocated.

And when you’re raising capital at a scale that’s worth a sovereign wealth fund’s consideration, you don’t have many other money wells to draw from.

Fund managers find themselves in the same pickle. So let’s say you’re the SoftBank Vision Fund, and it turns out that the public face of your anchor limited partner, Saudi Arabia’s Public Investment Fund, is a chap who got a guy broken and butchered in Istanbul. Well, you’re probably not going to return their uninvested capital, and you’re definitely not going unwind prior investments backed, in part, by that capital. In November, TechCrunch quoted SoftBank CEO Masayoshi Son as saying, “Before this tragic case happened, we had already accepted a responsibility to the people of Saudi Arabia to help them manage their financial resources, and we can’t all of a sudden drop such responsibility.”

To the extent that the market is in a bubble today, sovereign wealth has helped to inflate and prop it up.

But you could totally spin it as the investment equivalent of a one-time fling. Both parties could just go their separate ways. In November, Son said SoftBank “would like to carefully watch the outcome of the case and once the explanation is fully made then we will think about it once again.” At the start of December, reports surfaced that the CIA is in possession of messages tying Mohammed bin Salman to Khashoggi’s murder. With the window of reasonable doubt closing, the feasibility of Vision Fund II becomes even more uncertain.

And amid all this geopolitical pressure, Softbank’s Vision Fund, and other large funds, must also prove that huge direct investments can generate outsized returns.

Model Validation & Last Grasps At Growth

The amount of capital that’s about to get liquidity through IPOs next year is truly bananas, and some of it is from direct investments by government-backed funds. Two of the most hotly-anticipated debuts, Uber and Lyft, have both received direct backing from government sources.

Here are some predictions for how the market might react:

  • Validation: Favorable exit multiples generated from direct investments in late-stage technology companies will validate that investment strategy.
  • Replication: Attempting to chase others’ success, other sovereign wealth funds, which may not have previously invested in venture at all, will make their first direct investments in private technology companies in 2019. Longtime investors will accelerate capital deployment.
  • Desperation: As global economic growth slows down toward the end of a historic economic growth cycle, large fund managers may attempt to goose returns by investing more in high-growth private technology company equity.

Granted, all the above assumes that public markets remain reasonably stable. To be fair, this is shaping up to be a pretty big assumption. If 2019’s ticker tape reads like Q4 2018, all bets are off.

Global Influence In Global Markets

Giant venture rounds led by government-backed entities like the Vision Fund, Temasek, GIC, and others have already bent the shape of private-market fundraising for founders and venture funds alike, as we’ve covered extensively in the past.

To the extent that the market is in a bubble today, sovereign wealth has helped to inflate and prop it up. Deep-pocketed SWF investors have helped to reshape private markets like VC, but it’s also influenced public tech companies this year.

To that latter point, academics pointed to Elon Musk’s bungled attempt to take Tesla private—with Saudi backing which ultimately failed to materialize beyond acquiring a three to five percent stake in the electric automaker—as an example of sovereign wealth bending the public market upward.

Musk’s infamous “funding secured” tweet and Tesla’s official announcement on August 7th, followed up by another announcement on the 13th that expressly mentions Saudi interest in financing the over $70 billion take-private transaction, bumped up the price of Tesla shares. Even though the Public Investment Fund showed no interest in leading the buyout, the specter of possibility loomed.

At the same time, it’s also possible that the influx of sovereign wealth will drown the venture market. The academics mentioned earlier—King’s College London lecturer Robyn Klingler-Vidra and Harvard postdoctoral fellow Juergen Braunstein—point to other late-cycle surges of sovereign wealth, in other financial markets, as a cautionary note.

At this stage of the venture market cycle, direct investment at SWF scale is kind of like an intoxicatingly delicious high-proof beverage your friend brought to New Year’s party that’s already been raging for a few hours into the morning. It’ll be the last thing everyone remembers before waking up with a hangover, wondering what’s left that awful taste in their mouths.

Last bet: Most of 2019 will go by in a blur. 2020 will be the moment of reckoning.

Illustration: Li-Anne Dias

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