Yale’s Excellent Venture Capital Returns

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For the past ten years, Yale has earned an annualized return of 16% on its venture investments. The fair value of the venture investments is now $4.3 billion, which represents 16.2% of the $26 billion Yale Endowment. The results were included in annual financial statements for the university dated October 31, 2016.

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Source: Yale’s FY 16 Financial Statements

The Yale Endowment began moving away from traditional stocks and bonds to alternative assets, such as venture capital, after David Swensen took over as CIO in the early 1980s. For the past six years, venture investments, as percentage of the total endowment, grew from 10.3% in 2011 to 16.2% in 2016. For the past three years, the venture investments’ fair value has risen from $3.5 billion in FY 2014 to $4.3 billion in FY 2016.

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Source: Yale Endowment’s FY 15 Report and Yale’s FY 16 Financial Statements

More than the size of its investments, Yale Endowment’s commitment to venture capital is probable most important.  As an endowment, Yale is the ultimately long-term investor, who can wait to see the returns from venture investments; this is unlike recent venture investors such corporations, hedge funds, and mutual funds who may have shorter time horizons.

As an early investor in venture capital among university endowments, Yale was one of the first to established relationships with top tier venture capital firms. These ties have allowed Yale to be successful with its venture investments while other endowments have struggled. For example, Harvard’s endowment also announced FY 2016 results, including those for its venture investments. Harvard’s annualized return for the past five years was 6.2% and negative 1.5% for FY 2016.

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Source: Harvard’s FY 16 Financial Statements

Facebook’s 1st Stock Buyback is About Control

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Facebook recently announced a $6 billion stock buyback starting next quarter. Stock repurchases are common with mature, rather than growing companies such as Facebook. In fact early Facebook investor, Sean Parker, said when interviewed by Bloomberg, “Facebook has so much growth left in it”. The stock repurchase is a really way for Mark Zuckerberg to both maintain control and invest in the future.

Over the past four years, Facebook has expanded its platform with the acquisitions of Instagram, Whatsapp, and Oculus. Those companies were purchased with a combination of cash and stock. To purchase Instagram for $521 million, Facebook issued 12 million Class B shares for $221 million. Stock represented more than 80% of the consideration in the Whatsapp and Oculus purchases.  Facebook issued 178  million Class A shares for Whatsapp and 23 million Class B shares for Oculus.

Issuing millions of voting stock began diminishing Mark Zuckerberg’s control over Facebook. Class A stock gives its holder one vote and Class B stock has ten votes per share. So starting this year, Facebook distributed as a dividend to existing shareholders, the non-voting Class C. While it may be a good way to maintain control, the non-voting Class C stock is lousy for making acquisitions.

Founders of acquired companies are usually selling appreciated stock with large unrealized capital gains. The gains can be taxable and trigger a large tax bill when the company is sold for cash. But when the founder sells stock and receives stock in exchange, instead of cash, then the tax bill is delayed. Unfortunately the tax deferral only works with voting stock.

Deferring taxes is not for important tax-exempt limited partners such as university endowments, pension plans, and sovereign wealth funds. Paying of tax is important to individuals such as as founders, employees, and venture capitalists. Facebook recognized this fact it disclosed issuance of the class C stock:  

Sellers may have a preference for a transaction in which they can defer taxes owed, in which case we may have to structure the acquisition in a different manner or may be precluded from using shares of Class C capital stock to fund the acquisition.

To fund future acquisitions, Facebook needs either Class A or B shares. Issuing more shares is not an option since it will diminish Mark Zuckerberg’s control, but buying shares from existing shareholders is a solution. At the market price of $117, Facebook’s $6 billion could buy back approximately 50 million shares or 2% of the Class A shares currently outstanding. Rather than retire the repurchased shares, Facebook would just reissued them when the right acquisition comes along.