The economics of the tech industry is a chain with a bunch of confusing links. Startups get their money from venture capital firms, and we’ve talked about how that works and why it heavily influences who becomes key players in tech and what products end up in your hands. But how do venture capital firms get their money? Limited partners, or private corporations; state, county and city entities; and universities. Now, continue to follow me down the chain. Where do all these groups get their money from?
You. Or at least regular people just like you.
Private corporations and government funds are big funders of venture. (We’ll get to universities in a minute.) They use pension plans to make investments. That means they’re taking the money you’ve dedicated to, say, your retirement plan and investing it because they know it will be a while before you’ll withdraw those earnings.
“And so it’s ordinary teachers, firefighters and policemen who provide money to the pension funds that then invest in venture capital and private equity firms,” explained Peter Escher, the director of PitchBook, a private investment research firm.
Universities investing in venture use endowments — that thing that schools everywhere brag about because it pays for funding scholarships, courting named professors and remodeling buildings on campus.
Venture capital is a high-risk investment, so most put a small percentage of their money toward VCs. The Employees’ Retirement System of the State of Hawaii invests only around 1 percent of its total portfolio in venture, which is about $15.6 billion. Ultimately, just like any other investor, it’s looking for options that will give the state the best returns. But there are other ways the fund chooses to invest.
“We also want to find venture funds that are interested and will make investments in Hawaii technology,” said Hawaii’s Chief Investment Officer Vijoy Chattergy.
Venture capital also keeps organizations up to date on the newest technology and how all that could affect other markets they’re putting money in.
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“LPs like us invest in traditional infrastructure, like toll roads, parking lots — hard physical investment,” said Jagdeep Bachher, chief investment officer and vice president of investments of the University of California. His example: The rise of apps like Uber and Lyft could mean people are driving less, and that could mean people won’t need as much space to park their cars someday. “We do question the future of parking lots as a result.”
You would think firms are lining up to take everyone’s money, but it’s more complicated than that. Prestigious venture capital firms can be choosy about whom they work with.
“Not all limited partners are created equal in the eyes and minds and hearts of general partners,” said PitchBook’s Escher. “And so there’s kind of an unspoken, but tangible, hierarchy.”
For instance, the UC system is public, which means a certain amount of its investing information is available to the public through FOIA, or a Freedom of Information Act request. Firms generally want to keep their financial dealings hidden, so they might decide not to take money from a public university. They also might choose a school for the bragging rights: A deal with Harvard’s endowment can’t look too shabby.
In the end, each government entity and school makes the call as to how much they invest in venture. For some, that’s nothing. For pensions like the San Francisco Employees’ Retirement System, that’s a lot more. It’s at the top of the list of public pension funds investing in venture, committing to 47 firms, according to data from PitchBook. For comparison, Hawaii commits to nine.
But that vetting system can be worth it to funders. Bachher said the UC system’s venture investments have returned 16 percent over five years, and 11 percent over 10.
Chattergy said Hawaii is re-evaluating its investments in venture because though it’s getting a return, it’s not too high. One reason he wants to stick around?
“The types of companies, the entrepreneurs, the ideas and business models that they’re working with are really kind of cutting edge,” he said. “You know, you want to have some exposure to that because this is how you get intelligence about how the world might be changing.”