Public Markets vs. Venture Capital: Addressing Limitations

Draper Esprit's Transition to the LSE Main Board

Draper Esprit, a British venture capital firm, has recently transitioned its listing from the AIM to the main board of the London Stock Exchange (LSE). Simultaneously, the investment group relocated its secondary listing from Dublin’s Euronext Growth Market to the larger Euronext Dublin.

This move to the primary exchange aligns with Draper Esprit’s established ties to Irish capital markets.

The Rise of Public Venture Capital Firms

Draper Esprit has historically been an unusual entity – a generalist venture capital firm operating as a publicly traded company. However, this July saw Forward Partners list its shares on the AIM, indicating a growing trend.

Several other venture firms across Europe are also now publicly listed.

Questioning the Traditional Venture Model

The concept of a venture capital firm going public might initially appear counterintuitive, given their role in facilitating initial public offerings for their portfolio companies.

However, Draper Esprit co-founder Stuart Chapman expressed surprise in a TechCrunch interview, noting that venture capital has historically utilized a legal structure akin to a 1958 property vehicle, despite backing groundbreaking technological advancements for the past 70 years.

Limitations of the Conventional Approach

Fundraising success may have contributed to the relative stability of the venture capital model in recent decades, though fund sizes have increased.

The traditional model isn't without its drawbacks. It can impose artificial time constraints on investors and potentially narrow their investment focus to specific stages to facilitate fund construction.

Researching this topic revealed that the public venture model can highlight these limitations and potentially offer partial solutions.

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A European Phenomenon?

Currently, no U.S. venture capital firms have publicly listed in a manner comparable to Draper Esprit or Forward Partners.

To investigate the reasons behind the popularity of this model in Europe, The Exchange consulted with Draper Esprit, Forward Partners, Mercia, and Augmentum Fintech – all publicly listed venture investors.

Their insights suggest a confluence of factors contributing to the model’s appeal within the U.K. and its relative absence in the U.S.

Long-Term Implications of Public Ownership

Becoming a public venture capitalist fundamentally alters the dynamics of the venture capital business, shifting it towards a longer-term perspective.

These firms did not pursue public listings without careful consideration.

Let's examine the advantages, disadvantages, and regulatory considerations surrounding publicly listed venture capital firms. Is this a glimpse into the future, or simply a regional peculiarity?

A Shift in Venture Capital Listings?

Draper Esprit’s recent actions have positioned it as the largest venture capital firm focused exclusively on technology, currently listed on the London Stock Exchange’s Main Market. The firm’s original listing in 2016 was itself a significant event, representing an unconventional move for a venture capital entity, as Chapman noted.

This initial dual-listing occurred on both London’s AIM and Dublin’s Enterprise Securities Market (ESM), which is now known as Euronext Growth.

Within the past month, two further investment funds with a technological focus have launched initial public offerings (IPOs) on the London Stock Exchange: Seraphim Capital, specializing in space-related ventures, and Forward Partners, led by Nic Brisbourne. Draper Esprit provided informational support to both during their IPO processes.

Furthermore, the firm also made an investment in Forward Partners through its fund-of-funds strategy, as Chapman revealed.

This growing number of publicly listed investors now encompasses fintech fund Augmentum Fintech, asset management firm Mercia Asset Management PLC, and intellectual property commercialization specialist IP Group. Chapman expressed support for other firms considering similar listings, emphasizing the benefits of increased diversity within the market.

Nic Brisbourne, founder and CEO of Forward Partners, recently shared three key motivations that might prompt a fund to pursue a public listing. These include the ability to unlock value from initiatives beyond traditional investment activities, the potential to circumvent the continuous fundraising cycle, and the expansion of access to the early-stage venture capital asset class.

Let's examine each of these reasons in greater detail.

Reasons for Venture Capital Funds to List

• New Value Creation: Listing allows funds to pursue opportunities and initiatives that fall outside the scope of conventional investment capital.
• Fundraising Independence: Going public can break the reliance on repeated fundraising rounds, providing greater financial stability.
• Increased Accessibility: A public listing opens up the early-stage venture capital asset class to a wider range of investors.

These factors are contributing to a potentially significant trend in the venture capital landscape.

An Alternative Funding Approach

Brisbourne highlighted opportunities often inaccessible to traditional venture capital, referencing investments demanding a long-term perspective. Becoming a publicly listed entity provides a significant advantage for a venture firm, granting access to “patient” capital – or, as Brisbourne terms it, “permanent” capital.

“We anticipate that permanent capital will be instrumental in fostering innovation, accelerating development, and enabling more substantial, long-term investments,” he stated.

This observation relates to the freedom public markets offer from conventional venture capital cycles and the potential for reinvesting capital from public venture firms. Augmentum Fintech’s CEO, Tim Levene, explained that the inflexibility of traditional venture cycles was a primary factor in their decision to list on the London Stock Exchange (LSE) in 2018.

The prevailing sentiment was “dissatisfaction with the constraints of typical General Partner/Limited Partner (GP/LP) structures and the pressure to achieve peak returns within a defined timeframe, rather than simply optimal returns.” This proved particularly challenging within the fintech sector, “where companies often require extended periods to reach maturity.”

Conversely, as the sole U.K.-based listed fund exclusively focused on fintech, the firm potentially gains a competitive edge. Founders may view Augmentum as a long-term investor with aligned interests “in investment scenarios where they can identify an investor committed to sustained support.” This is because the fund “can continue investing throughout a portfolio company’s lifecycle without concerns about exceeding investment period limitations” – irrespective of the company’s stage.

Notably, the flexibility of listed funds, unburdened by standard VC cycles, also allows for deals to be “evaluated based on Internal Rate of Return (IRR) rather than multiples,” Levene noted. “Traditional funds have a single opportunity with each investment – a high IRR but low multiple over a short period may not be ideal; however, for listed funds with built-in recycling mechanisms, it can be highly appealing.”

Recycling of capital is a crucial aspect of listed funds. Draper Esprit articulated this in a press release: “Unlike private VC models that distribute returns to Limited Partners, Draper Esprit’s model allows for immediate redeployment into new investments, ensuring more of Europe’s promising startups secure funding.”

This also clarifies why continuous capital raises aren’t necessarily a priority. “Ideally,” Chapman observed, “realizations should match investments, creating a self-sustaining system.” Draper Esprit’s experience demonstrates this potential, having grown “from a listing value of just over £120 million to a market capitalization of approximately £1.4 billion” since its initial listing on AIM and subsequent move to the main markets.

Throughout this progression, Draper Esprit encountered limitations within smaller markets. “We enjoyed five successful years on AIM, raising capital annually – until our capitalization exceeded £1 billion. It became clear that to maintain our ambition and growth over the next five years, we needed to transition to a larger market offering broader access to funds and attracting a wider investor base,” he explained. Expanding the investor base is, in fact, a key benefit of listed VC funds.

Expanding Access to Venture Capital

The implications of a public venture capital model extend beyond benefits for venture investors and entrepreneurs. This approach has the potential to democratize venture capital returns, enabling individuals with modest means to invest in VC funds. Traditional barriers, such as U.S. accredited investor regulations and established limited partner (LP) networks, often prevent retail investors from accessing venture capital opportunities.

As highlighted by Stephen Johnson of Mercia, venture capital has historically been characterized as an asset class that is both difficult to understand and challenging to access. However, publicly traded venture groups are now readily available to the average investor through a standard brokerage account.

Levene of Augmentum pointed out another key reason why conventional venture fund structures often exclude smaller investors. The public-venture model facilitates exposure to both emerging startups and established growth-stage companies, circumventing the substantial minimum investment amounts typically required within LP structures for administrative efficiency.

Forward Partners’ Brisbourne emphasized the importance of broadening access to the early-stage venture capital asset class. This is considered crucial not only for the firm and its shareholders but also for the overall health of the U.K. startup ecosystem.

Early indications suggest that the anticipation of retail investor participation in listed venture capital firms is being realized. Brisbourne reported via email that demand from retail investors is robust, and the firm’s initial public offering was significantly oversubscribed.

Recently, Draper Esprit announced plans to secure approximately £111 million through an equity sale on the PrimaryBid exchange, specifically designed to allow retail investors to participate. It’s worth noting that Draper Esprit has a vested interest in PrimaryBid. The offering, which has now closed, was oversubscribed, with 603,500 shares sold to retail investors out of a total of 13,299,278. This represents just under £5 million in retail investment.

Consider, for American investors, the possibility of directing your next investment not towards a broad market index fund, but directly into a fund managed by a leading firm like Index or Sequoia. The potential is significant. However, the emergence of publicly listed U.S. venture firms may not mirror the trend observed in the U.K.

Key Benefits of the Public Venture Model

• Increased accessibility for retail investors.
• Lower minimum investment requirements.
• Greater transparency in the venture capital market.
• Potential for broader participation in startup growth.

Venture capital, once an exclusive domain, is becoming increasingly open to a wider range of investors. This shift could have profound implications for the future of innovation and investment.

The Preference for the U.K. Over the U.S. for VC Listings

Significant differences exist between the financial regulations of the United Kingdom and the United States. A key factor highlighted in numerous discussions is the presence of the U.K.’s Enterprise Investment Scheme (EIS). Established in 1994, the EIS was specifically created to stimulate investment in smaller, privately held companies, fostering increased private capital flow.

Draper Esprit, for instance, manages a substantial £150 million within EIS-designated vehicles. However, the complexity of becoming a publicly traded company in the U.S. may be an even more crucial consideration.

According to Chapman, the London-based “junior market proved very beneficial” during their initial public offering (IPO) process. Although the United States has taken steps to streamline the IPO process – such as allowing for private S-1 filings – exchanges in the U.K. and across Europe seem to provide a smoother pathway to public markets than currently available in the U.S.

Navigating Public Listing Requirements

The demands associated with going public in the United States are considerable. The expectations of regulators, coupled with the speed at which financial information must be disclosed, create a distinct contrast between listing on the Nasdaq and pursuing a flotation on the AIM.

Generally speaking, Chapman observed during a discussion with The Exchange that European regulators demonstrate a “positive attitude toward both innovation and established companies,” whereas his “counterparts in America express less favorable opinions regarding the SEC.”

The U.S. approach to regulating public companies evolved in response to instances of significant fraud. However, this doesn’t necessarily equate to a flawless system, nor does it automatically foster the same degree of public market innovation observed on U.K. exchanges.

The Future of Listed Venture Capital Firms

Is an increase in publicly listed venture capital firms likely? The indications suggest that it is. Several advantages exist that could motivate more firms to pursue this route.

Currently, however, this trend appears to be largely confined to Europe. It’s possible that future regulatory changes in the United States will create a more permissive environment, but until such adjustments occur, it’s unlikely that domestic venture capital firms frequently featured in industry publications will be filing IPO paperwork.