Elon Musk shocked markets and shareholders when he tweeted about his intention to take his electric automobile company, Tesla, private. He proposed that Saudi billions could help the company avoid the pressure of a stock exchange listing. IN blog postMusk said that “Saudi Arabia’s sovereign wealth fund [had] he approached [him] repeatedly about taking Tesla privately.”
Oil wealth combined with futuristic electric cars may sound like a strange mix. However, there is a growing precedent for one of these investment by sovereign wealth funds motivated by social and financial goals. So much so that they disrupt the functioning of capital markets.
The result may very well be disastrous. A glance at the history of enormous inflows into specific asset classes does not bode well for the enterprise capital industry. When petrodollars were introduced to the Eurodollar market in the Nineteen Sixties, it resulted in a sharp increase in asset values and then resets. Similarly, Japanese investment in American real estate caused a spectacular bubble and then crash. in the early Nineteen Nineties. In the Eighties, American investment banks borrowed on Latin American debt “a decade of lost growth”.
A standard refrain is “this time it’s different.” But it’s never different. We argue that the global increase in sovereign wealth fund investment in enterprise capital is fueling a similar cycle of asset inflation that can end in tears.
Huge sums of cash
The reason why money from sovereign wealth funds can prove destabilizing for enterprise capital (VC) is attributable to the nature of the way VC operates. Traditionally, agile investment firms, led by experienced partners with technical and operational expertise, would discover potentially disruptive technologies and then collaborate with fledgling firms on strategy, hiring and product. This “smart money” is said to have catapulted Silicon Valley tech firms into world powers.
But the small scale and snappy nature of enterprise capital is a relic of the twentieth century. Today, VC funds are backed by some of the largest investors in the world, including funds corresponding to Saudi Arabia’s Public Investment Fund (PIF) and Singapore’s GIC. Sovereign wealth funds invest huge sums of cash, each as limited partners in VC funds and as enterprise capitalists themselves.
The entry of sovereign wealth funds into the former enterprise capital cottage industry has intensified unprecedented levels of “dry powder” (money that VC funds have to take a position). With more cash at their disposal than ever before, VC managers are investing more cash in each deal and closing more deals. In recent quarters we could observe, among others: previously unexpected number and size “mega deals” (transactions price over $1 billion).
All of which means that when, as historical precedent shows, the VC bubble bursts, the effects will likely be enormous. Following the bursting of such a capital bubble, many start-ups that obtained early-stage financing at high valuations will likely be left with little capital. Investors, including sovereign wealth funds, will likely be burned by large losses and is not going to want to take a position in dangerous startups or enterprise capital funds for years.
The growing exposure of sovereign wealth funds to enterprise capital is linked to national development strategies and the revitalization of business policy. State investment funds have began investing in breakthrough technologies, from artificial intelligence to biotechnology. Countries with large funds, corresponding to Chinahave made clear their determination to maneuver up in the global value chain in order to proceed to grow.
Similarly, large oil exporters corresponding to Saudi Arabia need to diversify their economies around oil. Saudi Arabia’s Vision 2030 goals to position the oil kingdom as a global technology and financial center.
This initiative is spearheaded by the Saudi Arabia Public Investment Fund. PIF invested $45 billion in SoftBank’s $100 billion enterprise capital giant Vision Fund launched in 2017 and directly invested in June 2016 $3.5 billion in Uber. Most recently, in March 2018, it made a late-stage VC investment of value almost $1 billion at the augmented reality startup Magic Leap. Now he is in talks with Musk regarding taking Tesla private.
Watch out for the explosion
With the sudden influx of billions of dollars from sovereign wealth funds, the size of VC funds is skyrocketing – and so are the checks they write. Early-stage seed investments that were typically $500,000 can now be as high as $5 million.
With so much money to take a position, there is a sharp decline in multi-fund deals and less need for startups to go public. This results in fewer brains on hand to offer advice. It also means decisions are made faster, with less input from multiple sources. This may be each good (decisions may be made faster) and bad (there are fewer checks and balances).
When previous infusions of capital proved irresponsible, diversifying investment opportunities – geographically and by asset class – could have helped reduce systemic risk.
But measures may be put in place today to neutralize the rollercoaster of sovereign wealth fund investments in enterprise capital, so that the global enthusiasm for supporting start-ups around the world proves sustainable.
Funds should exercise moderation in their VC investing activities, for example by placing small bets in line with the rules of the VC industry slightly than implementing controls in accordance with the size of their funds. Their attractiveness as buyout partners, says Elon Musk, is simply not an easy alternative to demands for a stock exchange listing. The long-term health of Silicon Valley and aspiring Silicon Valleys around the world depends on their recognition.