TIFF plays the long game in venture capital

A few key issues are front of mind for the private markets team at the Investment Fund for Foundations (TIFF) Investment Management. The $9 billion asset manager, which serves around 500 foundation and endowment clients in the US, allocates around $3 billion to private markets and is famed for its venture and private equity allocation.

One is to ensure TIFF remains on the right side of the emerging winners and losers in the AI transformation, explains Brendon Parry, who joined TIFF in 2011 and serves as head of private markets, deputy CIO and managing director.

Fearful of missing out, investors have ploughed into AI and snapped up assets which have opened the door to mistakes like overpaying for companies that don’t prove as successful as they hoped, or even investing in fraudulent companies, he tells Top1000funds.com.

Positively, he notices managers intentionally layering AI onto existing businesses in ways that will solve internal pain points and increase efficiency. But he also predicts a gulf opening between VC-backed AI native companies and a cohort of also-rans, particularly those that date from before the most recent AI wave.

For example, companies offering software-as-a-service could potentially struggle to harness the efficiencies of rolling out AI compared to an AI-first competitor, which will impact their ability to retain customers and grow, he suggests.

“We generally feel confident about the companies we own in sectors most affected by AI transformation. However, when you examine the population of venture-backed companies that were started before this big AI wave but also missed the exit window in the hype cycle in 2020-2022, the question now is: are they going to be destroyed by an AI native company or be able adapt and compete against this wave of AI native businesses?”

Concerns about venture exits and NAV loans

Parry highlights that the exit market for private equity appears more buoyant today as more portfolio companies start to hire bankers and look to test the market.

But he says exits remain slow for venture-backed companies, weighed down by the mixed performance of companies post-IPO. That backlog is leading VC-backed companies to stay private for longer, delaying pushing for the exit because of the risk of selling out at unfavourable prices.

But he says holding off on exiting requires ensuring that the underlying portfolio is healthy, and a company is still creating value and growing in EBITDA.

“The companies in our portfolio are still accruing value and, at some point, will exit. The challenging exit market today is not top of mind for us because we believe our portfolio companies are still heading in this right direction,” he says.

So-called net asset value (NAV) loans whereby private equity investors borrow against their portfolio’s underlying assets to provide liquidity, extend investment, or offer early returns to investors are also a concern.

He is more comfortable with NAV loans being used to re-invest in the underlying portfolio, particularly with follow-on M&A in existing portfolio companies. But he doesn’t want the extra capital raised from LPs to be used as a source of funds to get cash back to LPs early.

It’s a trend that has spiked as more investors borrow against their private equity portfolios to raise cash since the slowdown in dealmaking activity has impacted their ability to exit trillions of dollars in older deals.

Avoiding these risks requires proper parameters and restrictions around NAV loans as well as LP advisory board approvals and disclosure, Parry says.

“We are not comfortable with NAV loans being used to generate liquidity to satisfy LPs,” he reiterates. “In a fund-level NAV loan, you are cross-collateralising all assets and adding a degree of risk. We are very careful about this.”

Access to the best managers

Parry oversees an annual VC and PE pacing model of around $100 million and $150 million, respectively. Strategy is focused on lower to mid-market opportunities in private equity, and early-stage venture capital. Typically, client endowments will have a 15-25 per cent allocation to private markets, depending on their own liquidity, he says.

“We want to generate significant alpha over public markets, and we want private markets to be a material part of their portfolio.”

He has no plans to add real estate or private credit. A decade ago, both private credit (distressed credit and solutions credit) and real estate were in the portfolio but dropped away due to an abundance of capital and competition at the time, making it harder to generate alpha over public markets. It also wasn’t the most effective use of endowments’ precious liquidity.

In private equity, investments target lower to mid-market opportunities where not only is there less competition; it is also possible to take a founder-led business, make it more professional and grow the EBITDA. It requires working with the right partners with sourcing acumen and the ability to win over founders; understanding when to invest – and when to stand back.

“Many years ago, we realised that in the lower mid-market PE, we have multiple ways to win beyond relying on access to cheap debt and favourable market conditions. In the small end of the PE market, even if the macro doesn’t cooperate, we can generate strong returns.”

Independent sponsors in private equity

In addition to actively investing with around 20 private equity GPs, TIFF has also partnered with independent sponsors for over a decade in its direct private equity sleeve in a win-win allocation that not only returns around 30 per cent IRR but also, over time, may convert independent sponsors into successful fund relationships.

The strategy, begun about ten years ago, was born out of the desire to generate returns deal-by-deal but also find and identify the next great PE firms early on. It has enabled TIFF to develop close partnerships, see “the good and the bad,” and go on to access their first fund as anchor investor with an information advantage not available to others.

“Approaching ten of the independent sponsors we’ve worked with have gone on to raise funds over the years. We’ve backed most of them. We typically end up partnering from independent sponsor right through to fund one, two, three and hopefully beyond.”

Finding independent sponsors who source, structure, and execute deals without managing a committed PE fund involves the typical due diligence of a first partnership with an emerging manager in an underwriting process that includes due diligence on the underlying company.

TIFF doesn’t invest directly in venture capital but actively backs around 20 “exceptional managers” who are able to find, source, identify and convince founders to let them invest alongside.

Celebrated partnerships include First Round Capital, through which TIFF has invested early on in a mix of exceptional companies that notably include Uber in 2010, supporting the business through its 2019 IPO that valued it at over $75 billion.

“Our focus is on finding managers that find founders that are solving a problem in the world and to become their earliest backer. Then you can generate outsized returns,” he says.

Accessing managers is a finely tuned, proactive sourcing process. It includes mining TIFF’s own extensive network, particularly its stella, past and present, advisory board for an endless source of introductions and warm recommendations, which means TIFF is often the first call for many venture firms. A combination of part process and part network means TIFF is present at scale in funds it is now impossible for new investors to access, says Parry.

“In venture, we have long-term, fantastic relationships with managers who we’ve backed from their first fund. Both existing and new managers also value TIFF’s mission to serve the investment needs of non-profits,” he says.