Venture capitalists have been heavily involved in backing AI and related technologies that are changing the face of business, but perhaps they ought to use these ideas in their own firms more. We speak to a San Francisco-based VC shop which claims to be doing precisely that.

The venture capital and wider private markets investment field has for some time been a favorite asset class for “patient” capital-holders such as family offices and ultra-high net worth individuals. VC firms deployed $201 billion in capital in the first three months of this year alone – more than the combined totals for 2010, 2011, 2012, 2013, and 2014.

But with such vast sums looking to be deployed, there is a speed issue. Or, rather, a lack of it. And the pandemic-induced lockdowns and associated disruption have only added to the difficulties of doing the due diligence checks on potential investment targets. VC may often back technology firms, but the actual investment process still has a whiff of old Wall Street about it. Shouldn’t VC embrace the kind of artificial intelligence tools that it also invests in? 

Ziad Makkawi, founder and chief executive of EQUIAM, a San Francisco–based VC asset manager, certainly thinks this sector needs to eat its own high-tech cooking. His firm claims to be pioneering a quantitative, systematic approach to VC investing. EQUIAM has two funds, its Private Tech30 Fund and the Private Alpha Fund. The latter fund is still open to fresh money from investors, as at the time of writing. 

The business operates on the assumption that there is enough data out there on firms that can be analyzed and used to manage a portfolio of VC investments quantitatively, Makkawi told this news service in a recent interview. 

“We believe there’s a broad audience that has been excluded from the asset class and certainly from the best-performing venture capital funds,” he said. “Most people don’t have access to the data or haven’t put in the effort to find it.”

“We have taken a risk-based approach to mitigate the froth that we see in the market right now,” he continued. 

And introducing more tech-driven ways of investing means that VC fees can come down and smaller investors can get a seat at the table. 

From a family office point of view, there are those FOs that are so large they are more like institutions and have the sophisticated investment teams to handle some of the challenges. Smaller single family offices don’t, and they often obtain only “sporadic” access to VC deals, and ticket sizes of entry are still high, Makkawi said. The EQUIAM approach means that a ticket size is as low as $500,000 in a diversified portfolio of VC opportunities is a big plus for smaller FOs, he said. 

Speed and range
The use of algorithms to drive the investment selection process greatly speeds up the process; the firm’s speed of deployment relative to other VCs and the use of the secondaries markets in VC also means that an investor’s holding period doesn’t have to be the typical VC 10-year one, but shorter, such as four or five years, he said. EQUIAM uses a “funnel” system, going from tens of thousands of potential opportunities to a handful. It uses as many as 80 separate metrics to rank and filter firms to reach the end point, he continued. 

EQUIAM can deploy investors’ capital in about a year while a traditional VC can take as long as four years, he said. 

Whatever one’s views of whether all these new funds can be easily absorbed into the market without compressing yields, the sheer numbers are impressive. EQUIAM cited data showing that VC funds are on track to raise $484 billion in capital in 2021 ($155 billion raised so far), which would obliterate the previous record of $402 billion in raised capital in 2018, if achieved. The sector is now more dominated by larger funds: The number of funds raising capital has plummeted, but the average size of funds raised in 2021 is $405 million, more than twice the size of an average VC fund raised in 2015. 

Although there is a lot of cash out there waiting for a home, EQUIAM argues that there is also a large supply of firms in which to invest. For example, firms remain private on average for 12 years before going public, almost twice the timespan of 20 years ago.

Makkawi has seen the VC sector surge in recent years, and shares some of the frustrations about how a sector that supports tech needs to embrace it more thoroughly. He has toiled in the asset management, private equity and investment banking space for more than three decades, and his career includes being CEO and founder of Algebra Capital (an asset management firm, sold to Franklin Templeton), as well as CEO of Istithmar World, Dubai Bank and Qatar First Bank. Other senior figures at his new business include John Zic, partner and founding team member, Kirk Oliver, director for placement and distribution and Arin Nazarian, portfolio strategist. Vijay Advani, former executive chairman of Nuveen, and Mike Ryan, co-founder and CEO of Bullet Point Network, are among the advisors to EQUIAM.

Crunching the numbers
Data is making a big difference, Makkawi said. In the case of the Private Alpha Fund, the algorithmically-driven system scores more than 500 from 8,000 companies and ends up investing in 30 to 40 of the top scoring firms. (In the case of the Private Tech30 Fund, it had a target of 30 to 40 ventures; it ultimately invested in a diversified portfolio of 38 ventures.)

The Private Alpha Fund, which was launched last June and is already invested in 13 firms, is even now showing double-digit returns on invested capital. Back-testing of the EQUIAM Systematic Ranking , which it employs, shows that this fund beat top-quartile VC funds as a category with less volatility and less correlation to public markets. The Private Alpha Fund charges a 2 per cent annual management fee and 20 per cent on carried interest - a fairly standard fee. The fund has a target size of $100 million. 

Dispersed
A big challenge in conventional VC investing is a wide dispersion of performance between the top and bottom quartile funds. Based on an average for the whole sector, the risk-adjusted return results for 75 per cent of funds aren’t very attractive, he said. 

One reason why it is now much easier for VC investors to shift in and out of their investments is the vigorous secondaries market. At present, EQUIAM reckons that the secondary market is worth up to $70 billion in the US alone. It also predicts that the venture capital direct secondaries market is expected to grow by more than 8x over the next 10 years.

What end of the field does EQUIAM play in? Makkawi said the business looks at late-stage and growth companies, such as Series B+ companies with market values greater than $250 million, as they are typically well established, with both revenues and addressable markets.  

“In addition, our algorithms only select companies with sufficient high-grade data quality. In practice, this means companies that have already completed three funding rounds (seed, A and B) and therefore have generated the requisite data. Our process eliminates companies that don’t meet our data-quality criteria,” he said.