🔥 Reference Newsflash

― By Reference Capital | June 2024 ―
General Technologies | Sustainability | Blockchain & Crypto | Life Sciences

Dear Partners & Friends of Reference Capital,
We’re hitting pause for the summer to focus on in-depth research and curate a spectacular lineup of content for our return in September. We hope you enjoy this month’s edition and truly appreciate your unwavering support. Have an amazing summer, and get ready for a dynamic and revitalized Newsflash in the fall!

– The Reference Capital Team

🦄 Cash is King — Turning Unicorns into Realized Gains

By Edouard Lingjaerde ― at Reference Capital

💸 Unicorns are Good, Cash is Better

Imagine you’ve just backed the next big tech unicorn. The company is growing, valuations are soaring, but the question remains: when will you actually see your money back? This is where Distributions to Paid-In Capital (DPI) comes into play, being a crucial metric for both venture capitalists and investors.

As we know, venture capital is a long-term game, where investments remain illiquid for multiple years before companies are able to exit. While the question “when will my investment exit?” remains similar to five years ago, the expectations around “how will it exit?” have changed significantly.

But here’s a key question: would you rather see modest returns quickly, or wait longer for potentially much larger returns? This dilemma is currently at the heart of evolving dynamics in venture capital.

🏋️‍♂️ Why Such Pressure for Liquidity?

Venture Capital, like Private Equity, saw a significant inflow of capital between 2018–2023. This was driven by significant unrealised gains during the low interest environment.

While there were many new limited partners entering the asset class during this period, most of this capital came from existing investors. Existing investors ended up increasing their deployment in these years, due to the increased pace of investment from underlying managers.

This all came to a head in 2022, as many mature funds did not take advantage of the 2020 and 2021 liquidity window to crystalize paper gains for LPs and are now struggling to find exit solutions.

This boating in VC has forced LPs to pull back on deployment until additional liquidity can be created to enable reinvestment. This is reflected in the dramatic decrease of ~50% funding from the peak in 2021.

Now with the IPO window closed and M&A remaining mostly muted, LPs are putting more pressure on VC Funds to figure out ways to generate liquidity in order to provide capital to reinvest in their next vintage.

👀 How Are Changing Liquidity Preferences Shaping Fund Strategy?

With scarce capital allocation in the venture space, there is a shift in preference by LPs towards funds that demonstrated both performance and liquidity. Investing in funds that navigate tough market conditions and deliver returns. As a result, capital is concentrating towards top-tier managers known for faster distributions to LPs. For example, top decile venture funds from 2017 have achieved returns exceeding 1x DPI, significantly surpassing the median of 0.2x and the average of 0.6x. This highlights the performance disparity between top managers and the broader market.

This LP preference is having a knock-on effect on deployment pace. While many GPs speak about a current “lack of attractive opportunities” to deploy capital, it’s clear there is also a reluctance to come back to market to raise a new fund without first creating DPI for existing LPs in their mature vintages. This has resulted in a significant build-up of dry powder — unallocated capital.

Mature Funds now face a critical decision: create liquidity by exiting investments or hold positions for higher future returns. While LPs often request distributions, many funds, despite showing promising paper gains (“TVPI”), are cautious about liquidating assets prematurely. Each strategy — quick liquidation versus holding for potential gains — has its merits. Venture funds generally maintain consistent distribution timelines, aiming to return investors’ capital by the seventh year, as fund managers are incentivized to maximize returns within a specific timeframe. This approach benefits both investors and venture firms, as the lack of liquidity affects not only the fund’s ability to meet distribution timelines but also impacts LPs’ strategies for future commitments.

🏪 Creating Liquidity in a Challenging Exit Market

People might have expected that the new normal would be years like 2021, where close to $800bn were distributed (and with a vast majority through IPOs). However, the market has shown that we don’t live in an attraction park anymore. With only $66bn in annual exit value in 2023, we’ve returned to levels similar to 2016, representing more than 90% decrease from the previous highs. And while the industry expected the general exit activity to slow down, we also expected an increase in the number of mergers and acquisitions relative to previous years, following cheaper private valuations — which did not happen.

But why did public listings stop so suddenly? When looking at the recent IPOs, we see that only best-in-class companies were able to sustain their valuations post-IPO. This likely scared many tech unicorns and their investors to go through a public listing. In addition, top companies still trade at a “private premium” to enable larger funds to extract as much value as possible before their IPOs. This incentivizes founders to stay private and take less risk around valuation volatility. Oftentimes, the funds encouraging this behavior are also the “brand names” that can keep raising new vintages no matter the macro environment.

While the market is tough, we are seeing some glimmers of hope with one recent successful IPO example, Reddit (RDDT), which saw a 175% increase in stock price since its listing. But even though Reddit went public at a premium to what the company was initially targeting, the reality is that it went public 35% cheaper than its previous private round, highlighting the points we are making above around incentives to be public.

🔁 Alternatives for Generating Liquidity

So, let’s summarize — we are in a market where companies are still (for the most part) not revalued, where exit activity is frozen, and where investors want to see distributions. So how do we get out of this bottleneck?

Well, fund managers have to become creative and find new ways to generate liquidity. While not reinventing the wheel, three strategies have recently emerged as alternatives to this liquidity drought:

• Secondary Markets — Secondaries have seen increased interest from investors, thanks to steep discounts in the private markets throughout 2023. Last year alone, close to $80bn was raised to invest in that strategy, which we expect to become more active in the coming months. Secondaries involve purchasing equity from other investors, often at a discount. The secondary market depends entirely on bid and ask prices, which in turn depend on where investors see the risk-reward for the opportunity, also fluctuating based on macro pressure.
• Continuation Funds — Continuation funds are new funds to which assets are transferred, allowing venture capital firms to continue supporting best-in-class portfolio companies, while providing liquidity to investors looking for distributions. To our early question around preferring modest returns quickly or waiting longer for potentially much larger returns, continuation funds provide investors with the ability to make their own judgment on this. On the other hand, this strategy also poses conflicts of interest, as venture managers will try to keep portfolio valuations as high as possible due to the carried interest paid to the previous funds.
• Private Equity Buyouts — Private Equity firms are nowadays quite familiar with venture investing, particularly within the SaaS industry. Bain & Company recently shared a research highlighting that $3.9 trillion of capital was available for private equity firms to be invested, with a good amount earmarked for venture opportunities. We have seen those players in more active conversations with our GPs about portfolio companies and have shown interest in emerging sectors outside of SaaS, acting as a potential alternative exit route to public markets or traditional opportunities. Overall, the lower late-stage valuations should act as a catalyst for better risk-return opportunities for PE investors.

🔮 Reference Viewpoint & Expectations

Everything we mentioned might sound quite pessimistic, with more pain still to be felt in the market from bankruptcies, down rounds and layoffs. However, if you were to read between the lines, you might’ve picked up on a few signals that might turn the balance. Indeed, we think that the private market still has the potential to face a Goldilocks scenario, if a few key triggers were to come together.

First, let’s say that interest rates get cut (which we have started seeing in Europe). Second, US presidential elections spur pressure for the White House to soften the macro environment pressures. Those macro tailwinds could provide sufficient ground for the IPO market to reopen, creating optimism and encouraging venture capital firms to resume deployment in private companies at higher rates. In turn, this could lead valuations and graduation rates to increase.

The question remains: are we headed for a soft or hard landing? While we don’t have a crystal ball (sorry!) and there are still many unknowns, we have seen that vintages from the years following 2000 and 2008 have resulted in decade-best performance. The years 2024 and 2025 could be the most interesting vintages in venture capital for the coming decade, which pushes us to optimistic while remaining cautious of the global environment.


Read/ Hear More ⬇️

• 🎙️ Limited Partner Unlocked: Michael Kim Cendana Capital on the Emerging Manager Landscape, Fundraising, and the Need for Liquidity — Venture Unlocked with Samir Kaji
• 📄 In Search of Liquidity; Navigating Today’s Illiquid Market as a GP — Industry Ventures
• 📄 Global Market Snapshot — Pitchbook
• 📄 VC Tech Survey — Pitchbook
• 📄 Global Private Market Fundraising Report — Pitchbook
• 📄 Is a chilly market for IPOs on the brink of heating back up? — Carta
• 📄 Unicorns — Dealroom

⭐Meme of the Month

In case you missed it…

General Technologies 🚀

🥇 Nvidia Becomes Most Valuable Public Company, Surpassing Microsoft

On Tuesday, Nvidia surpassed both Microsoft and Apple to become the world’s most valuable public company. This milestone is driven by the surge in generative artificial intelligence and the rising demand for Nvidia’s graphics processing units (GPUs), which are pivotal in creating advanced AI systems. Read more about Nvidia’s ascent here.

🛰️ Introducing Starlink Mini
Starlink, a SpaceX subsidiary, has launched its new product: Starlink Mini. This device offers portable internet with speeds over 100Mbps and is powered by a USB-C portable battery that lasts at least an hour. Starlink Mini aims to revolutionize global connectivity by making high-speed internet more affordable and accessible. Discover more about Starlink Mini here.

🎧 What We’ve Been Listening To This Month

• Training Data — Harrison Chase discusses building the orchestration layer for AI agents. Listen here.
• Sam Altman’s Opaque Investment Empire — OpenAI CEO has two roles, but only one makes him rich. WSJ explains that Altman’s wealth comes from investing in tech startups, some of which have ties to OpenAI, raising concerns about conflict of interest. Listen here.
• 20VC Interview with Index’s Founder — Danny Rimer discusses missed investments in Snap, Airbnb, Spotify, and Facebook, critiques VC practices, and shares successes like King and Discord, and failures like Nasty Gal. He also talks about Index Ventures’ strategies, the Benchmark partnership, competition, and post-Brexit UK optimism. Listen here.

Sustainability 🌍

⬆️ From the North: Unveiling the Hidden Sources of Global Emissions

Atmospheric Carbon Dioxide Tagges by Source: The Americas

Carbon dioxide (CO2) is the most significant greenhouse gas contributing to global climate change, with land and ocean carbon sinks absorbing about half of human emissions annually. NASA’s advanced modeling techniques help to identify and understand various CO2 sources and sinks. Seasonal patterns and regional details reveal how different areas contribute differently over time, such as North America’s seasonal vegetation changes and Europe’s consistent fossil fuel emissions.

⚡️ Levelized Cost of Energy: Market Trends 2024

Lazard’s 2024 Levelized Cost of Energy (LCOE) report highlights changes in renewable energy costs, emphasizing a shift in supply, demand, and financing.

Key insights from the report:

• Cost Trends: Wind and solar costs have decreased significantly since 2009 but have risen recently due to the Ukraine crisis and supply chain issues. Utility-scale solar PV costs nearly doubled from $36/MWh to $61/MWh in three years.
• Rising Costs: The lower ends of LCOE for wind and solar have increased, with onshore wind rising from $24/MWh to $27/MWh and solar from $25/MWh to $29/MWh, driven by high interest rates.
• Energy Demand: Growing demand from AI, data centers, and electrification necessitates a mix of renewable energy, storage, and firming resources.
• Market Impact: Higher costs are favoring larger companies, potentially pricing out smaller players.
• Tax Credits: IRA tax credits are significantly reducing costs for renewables and storage, but hydrogen development faces challenges due to new credit requirements.
• Nuclear Energy: Lazard’s analysis may disadvantage nuclear power by not fully accounting for its long lifespan and high upfront costs.

The report underscores the need for next-gen climate technologies to continue the energy transition.

💸 The Path to Cheaper Capital and Stable Growth

CTVC explains the shift from First-of-a-Kind (FOAK) to Nth-of-a-Kind (NOAK) projects, noting that FOAK projects carry higher risks and costs due to their novelty. Successful FOAK projects build a track record with consistent operations, attracting cheaper capital for NOAK projects, which typically raise about 80% of their capital from debt. This transition opens funding from institutional investors and conservative project finance banks, providing access to non-dilutive capital. However, funding options for FOAK projects are limited, making the journey challenging.

Capital availability against project stage (Source: Sightline Climate)

Blockchain & Crypto 💸

🗳️ Politics

• Biden campaign in talks to accept crypto donations (12 June).
• Trump said that he will advocate for crypto miners.

⚖️ Regulation

• SEC closed investigation into Ethereum as a Security.
• Taiwan advances crypto regulation with new industry self-governance association.
• Terraform — the company behind Terra-Luna — has agreed to a $4.5 billion settlement with the SEC.
• Binance will restrict the use of ‘unauthorized’ stablecoins within the European Union.

🏦 Financial Institutions

• MicroStrategy proposed private offering of $500 million of convertible senior notes to buy more Bitcoin.
• Kraken is in talks for pre-IPO fund raising round.
• Binance resumes Mastercard payments for crypto.

🔥 Top Stories

• Deutsche Telekom will soon start to mine Bitcoin.
• Solana releases Blinks, a new primitive transforming how users can interact on-chain, pushing the blockchain technology to the backend and providing better user experience.

🔎 Research

• 📄 Vishal Kankani (Multicoin) discusses the landscape of stablecoins and their latest investment in Mountain Protocol.
• 📄 Robert Koschig (1kx) evaluates the cost estimation in token economics for DePINs.
• 📄 Zack Pokorny (Galaxy) discusses the evolution of Memes and their place on Blockchains.
• 📄 a16z discusses how they started using DAOs to study political institutions and behavior at scale.

🎧Podcasts & Videos

• 📹 Bankless discusses the future of Bitcoin with the launch of BITVM.

Life Sciences 🔬

📈 AI-Driven Drug Discovery Company Makes 2024’s Third-Largest IPO in Hong Kong

QuantumPharm, operating as XtalPi Inc., a China-based AI and robotic automation drug discovery company, has made a successful listing on the Hong Kong Stock Exchange. This milestone enabled the company to raise approximately $126.8 million, boosting its market capitalization to $2.5 billion. Since its inception in 2015, QuantumPharm has raised a total of $732 million from prominent investors, including Tencent, HongShan (Sequoia China), and Google.

🏭 AI Adoption Among Biopharma Manufacturers Remains Limited

The integration of AI in biopharmaceutical manufacturing has been more moderate than in drug engineering. Although adoption is challenged by strict regulatory controls, the complexity of data collection, and high implementation costs, the need for consistency in production is key. Eclipse Ventures partner Justin Butler pointed out that consistent drug manufacturing requires deterministic systems, whereas AI, especially generative AI, has more variability. Still, AI can undoubtedly benefit biopharmaceutical manufacturing. For instance, it can improve the reliability of the supply chain by predicting drug demand and enable newer players to incorporate AI from their outset. Read more here.

🎗️ Challenges Persist in Advancing Cancer Treatments and Diagnostics

Global cancer rates are increasing, particularly among younger people (25–49 years), with a 24% increase since 1995. This increase is attributed to various factors, including obesity, environmental and lifestyle changes. Cancer research is well funded, with nearly 40% of pharmaceutical R&D investment going to clinical oncology, leading to advances in precision medicine. New personalized treatments, particularly immunotherapies, are promising but remain expensive and limited in application. Pharmaceutical companies are under pressure to lower drug prices while maintaining high returns to support ongoing research. Despite the persistence of cancer due to human biology, new diagnostic tools and treatments offer the potential to extend survival and demonstrate the value of biomedical funding. Read more here.

🥑 Another Avocado Seed Round Raised by Former Tech Giant Alumni

EvolutionaryScale was founded by Alexander Rives and colleagues after Meta disbanded its AI protein research team in 2023. Led by Lux Capital with contributions from AWS and NVentures, the team raised $142 million in seed funding. The company has developed ESM3, a generative model of biology trained on nearly 4 billion proteins that helps scientists design new proteins. This tool can generte precise formulas for protein production based on specified functions, with potential applications in drug development, cancer treatment, and environmental protection. The company offers the model for both academic and commercial use.

Not subscribed yet?

Subscribe Here