When it comes to venture, small is beautiful

Smaller venture capital IPOs have dramatically outclassed blockbuster floats in the sector since 2008, partly thanks to a big boost from biotech, according to data provider PitchBook.

Its third-quarter analysis of venture-backed IPO returns says: “Blockbuster IPOs that attract the most media attention, and raise the most money, produce a lacklustre performance. 

Recently, when Blackstone opted to sell its stake in insulation provider Armacell, who supplies the International Space Station, its partner Kirkbi, a family office owned by Kirk Kristiansen, held onto its stake

While these public listings represent some of the fastest-growing, and ambitious, start-ups, much of the value has already been factored in by VCs, leaving less opportunity for price appreciation in the public market.” Potential investors in float candidate Airbnb, the tech-driven leisure giant, should bear this factor in mind. 

Rather than letting stock market investors steal profits at an early stage family offices like to back companies until they mature. Recently, when Blackstone opted to sell its stake in insulation provider Armacell, who supplies the International Space Station, its partner Kirkbi, a family office owned by Kirk Kristiansen, held onto its stake.

Capital 54, a US family office owned by Greg Alexander goes further by spotting professional firms who have failed to achieve their potential and puts new money behind them, in a bid to help them to the next level.

Investors may yet have reason to regret the premature sale of biotech VC opportunities as a result of the demise of their backer, Woodford Investment Management. One of its stocks, Synairgen, has risen 560% since the start of July on news of a possible Covid-19 vaccine.

The post-IPO outperformance of smaller VC companies is illustrated by their dominance in PitchBook’s equal-weighted VC index, dominated by smaller businesses, up by an annualised 23.7% over ten years, against 13.4% for the S&P 500 and 9.2% for the cap-weighted VC index, where larger companies such as Slack, Uber and Spotify are heavily represented. 

The indices track the success, or otherwise, of listed VC opportunities for two years after an IPO, after which the stocks drop out of the picture.

A broadly-based ETF which uses a similar investment technique is sponsored by investment bank Renaissance Capital. It has benefited hugely this year from a surge in IPO outcomes, which also made a big impact on Pitchbook’s second-quarter data. 

The cumulative IPO differential in favour of the equal-weighted VC index is a stunning 670% over ten years. Even after taking account of market volatility, smaller VC opportunities are consistently ahead of their larger rivals. 

The post-IPO performance of smaller VCs is also good over five years, when the equal-weight VC index rose 23.5%, against 10.3% from the S&P 500 and 5.6% from the cap-weighted VC. 

Performance dropped in the first quarter of this year but surged in the second. In the year to the end of June the equal-weighted VC index was up 76.7%, roughly in line with the cap-weighted VC, against 15.1% from the S&P 500. 

Moderna Therapeutics and Zoom Video Communications, perceived as Covid-19 beneficiaries, have been outstanding performers. 

The PitchBook report says: “The top 10 performers in the index saw price increases of over 175% in the second quarter alone, which speaks to the exceptional price action that can drive outperformance over the market.” 

In early August, BigCommerce, an e-commerce software provider, saw its share price double following an IPO launch, after initially surging 290%. Investment bankers say strong market liquidity has increased the attraction of IPOs compared to trade sales.

As well as opportunities to profit from the pandemic, biotech offers investors access to early-stage growth due to a relative shortage of investment capital in the sector. They comprise half its equal-weighted IPO index, while cap-weighted VC is dominated by more mature software companies. 

The S&P 500 has performed well against the cap-weighted VC methodology because it has been driven by a small number of internet giants with huge market clout. Mainstream equal-weight indices have also underperformed the S&P 500 due to their lack of exposure to them, as have traditional small-cap indices.