Q&A: Top Tier Capital Partners' David York

Q: Why are we seeing such a surge of activity in the late-stage tech space globally?

A: There is a migration from public assets to private assets as they look for alpha, and it has fueled an abundance of capital in the buyout and venture markets globally. It has also fueled appetite for late-stage growth companies. Then SoftBank wants to own a major portion of emerging technology and has the Saudi Arabians – and other Gulf states worried about their fuel assets becoming less relevant in this brave new technology world and trying to get exposure to GDP outside their realm of expertise – investing alongside it. And Sequoia, as well as institutions like it, see the growth capital space as their franchise and want to protect and own it. This adds to the abundance of capital. 

Q: Where do mutual fund managers fit into this?

A: The mutual funds just have so much money. In the 1990s, Fidelity was the largest buyer of IPOs and it could dictate volumes because of the size of its allocations. Now, if Fidelity wants to own an IPO the allocation is not as meaningful as it relates to the firm's overall book. The only way to get meaningful ownership is by acquiring shares in the after-market but this pushes up prices. Fidelity – as well as Wellington Management, T. Rowe Price, Franklin Templeton, and Baillie Gifford – has figured out that it can buy the same companies privately, hold the shares for two or three years, and once an IPO happens it has 5-8% rather than 2-3% or less. This makes the position more relevant to the balance sheet. Regulation has helped, especially the JOBS Act, which allows private companies to talk to public market investors without disrupting their ability to become public companies. It means they can stay private for longer, and while some people would argue that's a problem, I would argue it's just the market and it's inevitable. I expect the late-stage private investment phenomenon to be around for some years. 

Q: So economic momentum will continue to swing towards the private markets?

A: This has been happening since the global financial crisis – maybe since Facebook when the early to late-stage investors received a multiple on their capital far above what public market investors have received. The public markets have also not been the most attractive place to acquire capital. Staying private is easier on management teams and on the companies themselves, given the pressures you see on becoming a public institution in terms of regulation and hedge funds looking to make margin on stock price movements.

Q: But these companies will still have to go public at some point…

A: There will have to be some form of liquidity – and 90% of our exits today are still through M&A. The biggest new entrant in the M&A market is the buyout funds, which now represent about 15% of activity in the technology start-up world. The technology shops have been most aggressive, guys like Thoma Bravo, Vista Equity Partners, and Silver Lake. They tend to look at these assets as something to add on to an existing portfolio company or they take two or three and merge them into a larger company. The Vista approach is to take a theme it likes in technology and build a company around it by combining several start-ups. It is often willing to pay more than strategic investors.

Q: What impact are these changes having on the early-stage space?

A: Series A and pre-Series A investors with funds of $400 million or lower are still focused on start-ups, technology, and people. Larger more traditional managers with funds of $400-800 million target mature Series A and B rounds, and then growth players like Sequoia, NEA, and Kleiner Digital Growth are typically Series C and above. Founders aren't normally worried about Series C investors but now you get Series C guys coming into the Series B space and disrupting valuations. Private equity and growth firms are coming down and Series A investors are building their own growth practices. We worry about this space, it is highly competitive. The question becomes what is your differentiation apart from capital?

Q: Are early-stage companies attracting more capital because they are developing faster?

A: Companies are getting into revenue much earlier and so the rounds become blurred. We aren't used to pricing revenue numbers in venture capital because historically our companies haven't generated revenue for 3-4 years. We are invested, indirectly, in 24 out of the 40 or so companies that have listed in the US so far this year and the average revenue for the prior 12 months was about $700 million. Spotify was in the mix, which pushed up the number, but in general, there's a lot of revenue. In 2009-2010, the average revenue was $20 million. Companies are bigger and valuations higher than we are used to, but they are also growing and producing revenue at a much faster rate.

Q: What trends do you see in terms of Asian appetite for US technology?

A: Participation by Chinese capital in the US was enthusiastic and growing, but it has since slowed down and in some cases, it's hard to see at all. Chinese companies that want to be global leaders must figure out how to distribute products in the US and China must figure out how to let US companies compete in its market. But the rest of Asia is still very interested in getting North American innovation exposure. Institutions in Korea, Japan, and Singapore want to commit to funds and make co-investments, and then corporates are probably even more enthusiastic.

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• Top Tier Capital Partners