The Vision Fund is composed of a unique hybrid structure of equity and debt
A routine $100 Mn raise in the Silicon Valley is now turning out into a $200 Mn fundraise
With the Vision Fund, SoftBank has enabled companies to dream BIG as a resource is not a constraint
In late 2016, the VC and PE industry was shocked by SoftBank’s announcement of its $100 Bn Vision Fund. The idea behind the fund was to invest in late-stage technology companies. Riding on its impressive 44% Internal Rate of Return over its 18 years of existence, SoftBank was able to close $93 Bn in commitments within just seven months.
As per publicly available information, investors are expecting to see at least 20% IRR from this fund. If we look at the US Venture Capital ecosystem, all the VCs collectively raised a cumulative of $143 Bn over the course of 4 years between 2014-2017. This is also four times the size of the biggest private equity investment ever raised.
The Vision Fund is composed of a unique hybrid structure of equity and debt. SoftBank itself has made a commitment of $28 Bn in equity. It has raised the remaining $72 Bn from external investors in the form of equity and debt. The debt portion adds up to a sizeable $45 Bn.
As per publicly available information, the debt portion of the commitment is in the form of preferred units. The investing period will be five years and the life of the fund will be 12 years. The high debt portion has its own set of advantages and disadvantages.
If the fund does well, the huge debt at a lower coupon will enable very high equity returns to investors but on the flipside, if it doesn’t (since the debt is in the form of preferred units), it will lead to almost no return eroding the capital.
Source: FT Research
The best thing about this “mother of all” funds is that the staggering cash may well shape the industries of the future. SoftBank’s Vision Fund till date has led huge investments in companies across sectors. It acquired about a 20% equity in GM Cruise, which GM bought in 2016, for $2.25 Bn.
SoftBank, along with the Singaporean sovereign wealth fund GIC and Sequoia Capital, invested $535 Mn in food-delivery company DoorDash. Dog-walking service Wag, raised $300 Mn from SoftBank giving it a 45% stake in the company. It also invested $865 Mn in a construction company Katerra. The biggest round of $9.3 Bn investment in Uber, makes SoftBank the largest shareholder in Uber.
The median global round size for late-stage companies in 2017 was around USD 11 Mn. The fund has already spent $30 Bn, nearly as much as the $33 Bn raised by the entire US VC industry in 2017. Within a year, the fund has a family of 24 portfolio companies.
The sheer investing power of SoftBank with large cheques are pushing incumbent VCs to raise large capital. Sequoia’s latest fund of $8 Bn is still small compared to Vision Fund but shows how top VCs are also raising large capital to write bigger cheques. General Catalyst recently filed for a $1.3 Bn fundraise, almost twice the amount it raised two years ago. Other funds that are considering a significant raise include Lightspeed Ventures ($1.8 Bn), Battery Ventures ($1.2 Bn) and Khosla Ventures ($1.4 Bn).
A routine $100 Mn raise in the Silicon Valley is now turning out into a $200 Mn fundraise. Brain Corporation, a robotics company has raised $10 Mn, before raising $100 Mn+ from SoftBank. Similarly, Improbable raised only $52 Mn before closing its $500 Mn round with SoftBank.
These inflated round sizes are making other VCs to either write bigger cheques or drop out. FOMO has led VCs to conserve capital for investing in late stage deals. This has led to a significant gap in Series B/Series C stage investments. However, this has also opened an opportunity for early stage VCs to focus on Series A/Series B investment and look to Softbank for a potential exit.
This competition to deploy capital and grab deals has led to inflated valuations. For example, if WeWork’s valuation was based on the multiple of sales like its competitor Regus, then it will be worth much lower than current valuation of $28 Bn. The investment in late-stage also has a significant impact on liquidity (exit).
Incremental, late-stage capital delays going public and consequently exit. As can be expected, there is no “free lunch”. Our research shows that large round sizes are usually accompanied by non-standard terms from the investor. These include some covenants related to decision making as well as further capital raises, for example.
With the Vision Fund, SoftBank has enabled companies to dream BIG as a resource is not a constraint to hire top talent, for example. Its ability to back companies give founders a fair chance to compete against the likes of Amazon, Google, Facebook etc. Higher establishment and living costs are shackling startups in Silicon Valley and a healthy capital raise helps alleviate these factors.
However, companies will come under increased pressure to show commensurate growth vis-à-vis the capital deployed and justify the premium on valuations. It also puts pressure on the company to raise subsequent funding rounds at a higher valuation.
In its quest to show growth, companies may be forced to burn disproportionate capital without much regard to profitability and grab market share, for example. Sustainability of business models propelled by capital may come under a cloud when the cycle turns and capital runs out before you build a business.
Secondly, by writing large cheque sizes (than the norm), Softbank is trying to propagate a concept that Capital is the biggest moat. While some businesses do need high capital to disrupt traditional business models, attract customers and retain them or change customer behavior, companies flush with excess liquidity often leads to profligate behavior. A culture of respecting capital is also imperative in the early stages of a business and it will be interesting to see how this pans out.
There is also an apprehension among companies (whose business models particularly are capital intensive) that if they don’t accept capital from SoftBank, they may cede space to rivals. SoftBank’s investment in cab hailing companies started with $20 Mn investment in Ola in 2014. It soon invested in Grab in SE Asia, Didi in China and Brazil’s 99 (string of pearls strategy).
Since all companies aim international expansion it may have been the right call for Uber to secure funding from SoftBank. Secondly, since most of these would be a “winner takes most if not all” plays, a common investor like Softbank would benefit.
Recently, Vision Fund also came under scanner (for no fault of their own) for having the Saudi Arabia’s Public Investment Fund (PIF) as their largest LP, given the incident around the disappearance of Adnan Khashoggi. The PIF had also committed another USD 45 Bn for SoftBank’s Vision Fund II.
Though Masayoshi Son has not made any public statement on his stand vis-à-vis Saudi investment, it remains to be seen how Son deals with international pressure surrounding this. Though companies like Uber and Wework were not part of the FII conference, they got a backlash for being funded by Saudi’s money through the Vision Fund.
Uber had earlier received USD 3.5 Bn investment directly from PIF in 2016. It would be interesting to see whether Softbank can pull off another Vision Fund without their largest LP and whether companies will have reservations accepting capital from Vision Fund.
In conclusion, for capital-starved countries like India, Indonesia and others, SoftBank’s Vision fund is a blessing, which has given significant impetus to several startups like Flipkart, Paytm, Grab, Go-Jek and others. Flipkart, at one point of time, was struggling to raise capital and SoftBank’s timely infusion helped them to consummate the historic deal with Walmart.
Few VC firms can match SoftBank’s global reach. More importantly, when SoftBank invests in 50-70 companies (at steady state), it will have one of the biggest global pools of tech firms valued at multiple billions of dollars. This ecosystem will be incredibly powerful as the strength of any VC comes from the ecosystem it builds.
SoftBank also mentioned its plan to raise Vision Fund II with twice the size of the first fund. Son claims that Vision Funds 2, 3 and 4 will be established every two to three years and will have a portfolio of about 1000 companies in a decade. Venture Capital Funds pride in investing in disrupting businesses. Softbank’s Vision Fund is disrupting the Venture Capital Industry in a manner and scale that is unprecedented. Only time will tell if we are heading towards a one-man bubble or a powerful conglomerate led by an audacious visionary.
[This article is co-authored by Shailesh Ghorpade, Managing Partner and CIO of Exfinity Venture Partners and Mohit Babu, Associate of Exfinity Venture Partners.]