Hedge Funds, Desperately Seeking Return, Go VC

TechCrunch reports a rumour that an unnamed hedge fund will lead a $30 million round for Valley darling Zazzle–at a $300 million valuation.  Assuming the rumour is true, the important news for the broader industry is that the lead investor is a hedge fund.  A New York venture capitalist, meanwhile, reports that almost every hedge fund he has spoken to in recent months is gearing up to put significant dollars into VC -type investments.  This trend is great news for companies seeking capital–and awful news for investors.

The standard long/short tech hedge-fund business has gotten so competitive that funds are being forced to stray far from their roots to post competitive returns.  One easy way to do this–in a bull market–is to invest in hot, late-stage private companies that will soon go public or get acquired.  This practice became popular in the late 1990s, because it was, briefly, the equivalent of shooting fish in a barrel.  (For funds that began investing in 2000, meanwhile, it resembled tossing cash in the incinerator).

The good news for entrepreneurs is that more investors in the market means more potential sources of capital and higher valuations.  The bad news for investors is that most hedge funds don’t know private markets as well as public ones and therefore tend to be less-smart (in this arena) than, say, focused VCs and private equity firms.  In the 1990s, the entry of “cross-over” funds and other non-traditional investors into late-stage VC investing was (in hindsight) a sign of the top.   

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