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February 27, 2006

Why VCs need to watch out for hedge funds

Bill Burnham has a detailed analysis on how hedge funds, having invaded the territory of Private Equity funds, can "rapidly gain a major presence in Silicon Valley".

Not only do they have the capital, but they have the economics that should allow them to recruit many of the top performing partners, especially the younger generation of “up and coming” partners that are on the losing side of the fee and profit skew. The ironic thing is that most hedge funds will probably do this as almost an afterthought. With some funds having gross exposures in the tens of billions of dollars, they could dedicate just a few percent of their assets to venture and become a major player overnight. While the direct returns on such funds probably wouldn’t move their own needles, the private market information flow that the hedge funds would gain access to could be worth a few hundred basis points of edge on their public holdings.

Is this relevant to India? Given that most VC firms in India - including some of the Silicon Valley VCs - currently prefer investing in late-stage and pre-IPO companies (typically, the turf of Private Equity firms in mature economies), the danger of clashing with hedge funds indeed seems real. And, by the way, the list of investors in the example that Burnham provides to illistrate how hedge funds are "dipping their toes in the late stage end of the VC market" - the recent $130 million financing raised by San Francisco-based payment systems developer Pay By Touch - includes Farallon Capital, which continues to pour dollops of capital into Mumbai-based Indiabulls and its group companies.

Arun Natarajan is the Founder of Venture Intelligence India, which tracks venture capital activity in India and Indian-founded companies worldwide. View sample issues of Venture Intelligence India newsletters and reports.