Sovereign wealth funds to the rescue of innovation financing
The most innovative country in 2020 remains Switzerland before Sweden and the United States according to the rankings of the 13th edition of the World Intellectual Property Organisation’s global innovation index (WIPO). The United Kingdom and the Netherlands follow the trio and Asia is getting strength in the global innovation landscape year after year. The picture is not all bright for innovation though since WIPO sounds the alarm on the future of innovation financing.
The organisation points out the sharp decline of venture capital deals across North America, Asia, and Europe, given venture capitalists currently rather back mega-deals than finance small new start-ups, as well as the rarefication of IPOs in 2020. A solution may come from sovereign wealth funds that have become a “major factor in technology and innovation investing globally” and emerged as important sources of capital to traditional venture capital firms, increasingly as direct investors. This trend was explored, in the report, in a focus authored by Jerome Engel (University of California), Victoria Barbary (International Forum of Sovereign Wealth Funds), Hamid Hamirani (Ministry of Finance Oman) and Kathryn Saklatvala (bfinance).
High-quality tech investments preferred
SWFs with mandate to overseas investments are increasingly encouraged to look at more local investment opportunities or use their international investments to foster technology transfer or business model extension into the local economy, the quartet first notes. “SWFs investing at home, therefore, have greater opportunities to invest in companies with innovative products that can potentially be a potent force of change in all parts of society, including service industries, creative industries, and the public sector. We are only at the beginning of this trend. While domestic investments are still a small proportion of the whole, they have grown in number year-over-year since 2015. Nevertheless, these investments come with their own challenges: avoiding conflicts of interest and unsound, politically motivated investments, and preventing crowding out private capital,” add the authors.
From a geographical perspective, the US and Asia remain before Europe prime destinations for SWF technology investments. Sector-wise, a shift is noted as SWFs tend to drop direct investment focused on consumer services with high-tech elements (e-commerce, consumer technology, etc) to focus on high-quality tech.
“In today’s investment climate, sovereign wealth funds with high-quality technology investment programs are likely to be attracted to sectors that may have significant public policy, foreign policy, public safety, national defense, and security implications. This is not a politically motivated move; in a market where many tech businesses struggle to turn a profit, these types of products and services often have more robust intellectual property-based business models and income streams.
“However, while geopolitics remains a major consideration for SWFs investing in foreign technology companies, there is a new frontier for political considerations—those of major global technology companies. As firms such as Alphabet, Facebook, and Amazon gather ever more data about their users, they are increasingly shaping people’s lives and politics,” explain the authors. Hence they advise SWFs to be cautious on potential reputational and political implications, “both for them as an investor and for their government as an owner”, when backing the new GAFAs.
The same applies to SWFs’ home tech investments as the role of the government in these companies could potentially raise questions from home citizens. The authors however believe that SWFs can provide a strong governance framework, risk appetite, investment expertise, financial capacity, and culture to help grow these companies. “However, if governance is compromised, then there is a particular risk that these institutions are captured by politicians to pursue non-commercial technology ambitions.”
SWFs come earlier in VC funding rounds
The authors stressed that experienced SWFs are developing internal skills to allocate capital for direct investment in companies at earlier stages of capital raising. But later-stage or pre-IPO companies remain favoured. “To successfully execute more direct, early-stage, and multi-stage investments, SWFs need to develop hands-on skills in every aspect of portfolio construction and governance,” penned the authors, adding that cognitive diversity in teams is another key component to take into account for SWFs.
The most common strategy used by SWFs is to co-invest alongside their venture capital managers. The authors notice that in 2019, the trend of sovereign funds investing as part of consortia reached its highest level, particularly in sectors like healthcare and technology. "Sovereign funds’ involvement in consortium deals in technology companies has more than tripled since 2016. In 2019, the trend continued with SWF preferring to partner or co-invest in innovative industries. Eighty-three deals in healthcare and technology were completed as part of a consortium, versus sixteen as solo investors," the authors said.
In conclusion, they assessed that SWFs should become more aware of ways of investing “to help address the increasing vulnerability of the global economy to major macroeconomic, political, environmental, and health shocks and disruptions, and become more proactive in enhancing their capabilities to do so.” Another recommendation is that the SWFs should pursue their investments aimed at enhancing technology development and business model innovation, both globally and domestically. Furthermore, the authors believe that more can be done by the SWFs on the matter of social challenges, “perhaps without significant (if any) sacrifice to financial returns.” Lastly, regulation should adapt to the increasing impact of larger investors, including SWFs, in the later-stage private equity market.