(Bloomberg) -- In recent months, venture capital firms and mutual funds have become choosier about which technology startups they’re prepared to back. Now hedge funds, after helping push valuations to dot-com-era heights, are getting more picky, too.
Last month, hedge funds participated in the fewest number of venture capital rounds in U.S. tech companies since 2013, inking just two deals, according to research firm PitchBook Data. Even Tiger Global Management , an early backer of Facebook and LinkedIn with $20 billion under management, has pulled back. Smaller firms are getting out altogether.
Like VCs, hedge funds are more circumspect because some startups have failed to live up to their billing. Plus, in the wake of several disappointing tech IPOs, many of the most promising firms are choosing to stay private longer, meaning it takes longer to cash out. Investors’ stinginess is forcing startups to cut costs, fire workers and accept more stringent terms when raising money.
“We’ve completely stopped investing in private tech,” said Jeremy Abelson, a portfolio manager at Irving Investors, a small hedge fund based in New York. “I’m done with intangible valuations, unknown exits, unknown liquidity, and I want something that if I put my money into it now, I’m not going to hit a grand slam, but I’m going to get something that’s immediately yielding.”
Hedge Funds participated in 38% fewer global VC-backed deals from the third to fourth quarter of 2015, according to PitchBook. The total completed deal size dropped from $9.1 billion to $4.6 billion in the same period. The pullback is especially squeezing late-stage financing for tech companies, and pushing up the number of so-called down rounds -- when startups accept a lower valuation in exchange for funds. The final stages (Series E and later) of financing based on lower valuations jumped to 26% in the fourth quarter last year, compared with 11% a quarter earlier, according to Fenwick and West.
In years past, hedge funds lacked the patience required to back tech startups, risky investments that often take years to pay off. But the latest generation of Valley firms have real businesses (unlike many of their dot-com counterparts) so hedge funds have been competing with VCs for some of the biggest deals.
For example, Coatue Management, a so-called crossover fund that invests in public and private companies, led a $55 million fundraising round for Snapchat. Valiant Capital Partners backed Pinterest, Dropbox and Evernote.
Some small hedge funds were attracted by the outsize returns reaped by larger firms, such as the $3.2 billion paper profit Silver Lake Management earned when Alibaba Group Holding went public last year.
“Hot markets generate fair-weather players,” said Ben Narasin, a partner at Canvas Ventures, a Portola Valley, California, VC whose partners invested in such startups as Lending Club and Houzz. “Everyone rushes to the new shiny thing.”
But in recent months, some startups have put initial public offerings on hold after watching once high-flying firms stumble once they went public. Esty has lost almost half of its value since its IPO a year ago. Square and Match raised less than anticipated. Square’s pricing of $9 a share in the IPO fell short of the $15.46 a share it sold stock for in its last private funding round. Match is trading below the IPO share price.
In 2013, tech investors could expect an average return of 160% from the last private fundraising round to IPO, according to data compiled by Irving Investors from BVMarket Data. In the second half of 2015, the average return fell to 29%.
Big hedge funds haven’t abandoned the U.S. tech market; they’re just getting choosier. For example, Tiger Global Management, which bills itself as an investment fund with a separate venture arm, made four U.S. investments in 2015, a drop from 12 a year earlier, according to CB Insights. (That doesn’t include Tiger’s big stake in Uber last December, which hasn’t closed yet.)
Dragoneer Investment Group backed four U.S. tech startups in 2014 (including Instacart and Airbnb) and just one last year (Dollar Shave Club), according to CB Insights; in 2014 Valiant backed two (Instacart and Uber) but invested in no U.S. tech companies last year.
“It’s not a liquid asset class,” said Ilan Nissan, a partner at Goodwin Proctor that advises hedge funds and venture capital funds. “You need to be willing to sit there and not be able to mark it everyday and know what your position is worth. As IPO markets go sideways, it makes sense that they’d be shying away from that asset class.”