What the Iron Man-like character is claiming for his futuristic automotive company is not unheard of. On a systemic basis, mammoth institutional investment—especially from sovereign wealth funds (SWFs)—is flowing into start-ups and technology-oriented publicly traded companies. In this case, Saudi billions would help Mr Musk escape the pressures of being publicly listed. SWFs have invested large sums into high-growth start-ups promising innovation and financial returns. In fact, just this month, Saudi’s Public Investment Fund (PIF) announced a US$1bn investment in Tesla’s rival, Lucid, and a US$2bn stake in Tesla. The rise in SWF balance sheets and activity is having ramifications on global efforts to be more Silicon Valley-like, and on Silicon Valley itself.
A look at the history of large inflows into specific asset classes does not bode well for the venture capital (VC) industry: when petrodollars were funnelled into the Eurodollar market, it drove asset spikes and then resets. Japanese investment in American real estate fuelled a spectacular bubble—and then crash—in the 1980s. US investment bank lending in Latin American debt ultimately culminated in a “decade of lost growth”.
typical refrain is that “this time it’s different”. It is never different. We argue that the global rise of SWF inflows into VC—both in equity and debt forms—is driving a similar cycle of asset inflation that will end in tears. The reason that SWF money could prove destabilising for VC comes from the nature of the way VC works. Traditionally, nimble investment firms, led by experienced partners with technical and operational expertise, would identify potentially disruptive technologies and then work with the fledgeling firms on strategy, hiring and product. This “smart money” is said to have catapulted Silicon Valley technology firms into global powerhouses. For its part in the magic of Silicon Valley, VC became a darling of policymakers keen on supporting Schumpeterian cycles of creative destruction, which are meant to drive the innovation central to elusive economic growth in the post-global financial crisis context, around the world.
But the small scale and scrappy nature of VC is a relic of the 20th century. Today, VC funds are backed by some of the world’s largest investors, including SWFs such as Saudi Arabia’s PIF and Singapore’s Government Investment Corporation (GIC). SWFs are investing huge sums of money, both as limited partners in VC funds and as venture capitalists themselves, as shown in below table. The entrance of SWFs into the previous cottage world of VC has fuelled unprecedented levels of “dry powder” (money that the VCs need to invest).
SWF’s increasing exposure to VC comes along with national development strategies and the revival of industrial policy. State-owned investment funds have started to embrace disruptive technology investments from artificial intelligence (AI) to biotech. Countries such as China are determined to move up in the global value chain to escape the “‘middle-income trap”. As outlined in the Made in China 2025 plan, China wants to become a major competitor in advanced manufacturing and leader in cutting-edge technologies, including AI, electric vehicles, pharmaceuticals and advanced microchips.
In a similar fashion, policymakers of oil exporting countries are strong-willed to diversify their economies in the context of a changing global energy mix. Saudi Arabia’s Vision 2030 strives to position the oil kingdom into a global technology and financial hub. The kingdom aims for the PIF to be the largest SWF in the world (managing more than US$2trn in assets by 2030), and for its investments in frontier technologies to help forge its diversification efforts.
Saudi Arabia’s PIF is an illustrative case; it committed a massive US$45bn investment to Softbank’s mammoth US$100bn VC Vision Fund launched by Masayoshi Son in 2017, and in June 2016 directly invested US$3.5bn in Uber. More recently, the Saudi fund led a late-stage VC investment of US$963m in Magic Leap in March 2018. And this is all before the recent string of investments in Tesla and Lucid.
With the billions of dollars suddenly flowing in from SWFs, the size of VC funds is growing, and so the size of cheques they need to write are ballooning. VC investments at each stage—seed, A and B rounds—are exploding. Seed-stage investments were typically US$500,000, but can now be up to US$5m. There’s a rise of “mega deals” across later stage VC rounds, which used to be firmly private equity territory. According to KPMG’s Venture Pulse Q1 2018 report, there were five mega deals in Q1 alone. With so much money available for big-ticket VC investments, there is a sharp drop in the propensity for syndicating deals whereby multiple funds participate, and then later on there is reduced appetite for capital raising through public equity markets. With SWFs coinvesting alongside VC funds, there is scant need for involving multiple funds in each investment round. This means there are fewer brains available in the pool of “smart money”. But on the upside, it means there are less collective action challenges, so strategy, hiring and subsequent fundraising decisions may be easier to make.
When previous floods of capital proved irresponsible, a diversification of investment opportunities, geographically and asset class-wise, could have helped ameliorate the systemic risk. Counter-cyclical measures can be put in place today to neutralise the rollercoaster that SWF investment in VC is propelling so that the global exuberance for supporting start-ups and spawning Silicon Valleys proves sustainable. SWFs should be modest in their VC investment activity, placing small bets in line with the workings of the VC industry, rather than trying to deploy checks in line with the size of their funds. Their appeal as buy-out partners, as Mr Musk is alleging, is not simply an easy alternative to the demands of public equities markets.
Dr Juergen Braunstein is the co-author of this blog. He is a fellow at Harvard Kennedy School’s Belfer Center and author of Capital Choices: Sectoral Politics and the Variation of Sovereign Wealth (forthcoming).
This summer, Elon Musk jolted markets, especially his shareholders, by leaking his intention to take Tesla private.