Why fund structure matters
Valuation considerations for listed VCs
This is not investment advice and is for informational purposes only. Investors should conduct their own research.
Elon Musk was the defining entrepreneur of 2024. Last year, his companies (in no particular order): caught a rocket out of thin air (SpaceX), unveiled the Cybercab (Tesla), raised $6bn for xAI, commenced human trials for Neuralink, built a supercomputer with 100k Nvidia H100 GPUs (xAI), expanded the Boring Company’s tunnels in Las Vegas, and launched Grok on X. Oh, and he became the ‘First Buddy’ after a $277m investment catapulted Donald Trump to electoral victory. To paraphrase Musk’s question to ex Twitter CEO, Parag Agrawal, “what did you get done last year”?
As a result of the above achievements, Musk’s wealth increased by $200bn last year. It is therefore not surprising that several investment groups are seeking to build a type of ‘Musk ETF’ to enable the public to benefit by owning a small part of these enterprises.
However, as we will see, the structure of these investment groups has significant implications for how Musk’s value creation is captured for investors.
Destiny XYZ (ticker: DXYZ) and Cathie Wood’s Ark Ventures (ticker: ARKVX) could be perceived as proxies for Musk’s ventures. Both groups are seeking to build portfolios of private companies in a public wrapper. 37% of Destiny’s portfolio is in SpaceX, while 15% of Ark’s portfolio is spread across numerous Musk’s ventures: SpaceX (12%), xAI, X, and Tesla.
Yet the divergence in their performance since the US election highlights the importance of structure. Since the election (and to the end of 2024), DXYZ’s closed-end fund structure increased in value by 450%, while Ark Ventures increased in value by 12%. (Musk’s wealth increased by 77% since the election to the end of the year; S&P was up 3% to the end of the year by way of comparison)
No wonder DXYZ’s CEO, Sohail Prasad, is trolling Cathie Wood on X.
Hats off to the DXYZ crew. They have executed well here, with a heady cocktail that combines a portfolio of high profile brands, successful storytelling on social media and an attractive structure for investors.
Yet this is not to argue that DXYZ’s modus operandi should necessarily be replicated. DXYZ’s current valuation of more than 10x NAV gives the operation a distinct whiff of memecoin. Narrative has eclipsed reality. Some of us more trad finance folks still believe that the market will ultimately value predictable cashflow generation.
In this post, we are going to consider why different public investment managers of private assets select different structures (focusing on DXYZ vs Ark), propose potential valuation techniques for listed VCs, and consider how listed VCs might seek to trade at a premium to NAV.
Why go public in the first place?
VC is changing from a cottage industry into a proper globalized asset class. And its investor base is changing with it. VC is no longer just the preserve of endowments and institutional investors.
The traditional GP/LP structure works well for investors who benefit from pass-through taxation (especially for tax exempt investors) and who like the perceived low volatility of private markets. The carry structure also incentivizes alignment with investors to drive performance (although you could argue that this has been gamed by the new asset accumulators who prioritize management fees to carry).
Yet the unpredictability of liquidity is the critical issue in venture capital today, which has led to a major slowdown in fundraising since 2022. By contrast, a public structure enables investors to convert MOIC into DPI at will. With greater transparency forced upon a listed manager (with regular financial disclosures), investors should have a more accurate view of value.
There is a broader theme at play in terms of the democratization of alternatives, with retail investors seeking to branch out from a 60/40 equities/bonds portfolio construction. A listed entity also enables any investor, not just accredited investors, to own a slice of the next big startup.
Finally, a listed structure allows for scalability (as the entity can allow for the addition of new capital) and compounding of returns (as exits can be reinvested immediately). In due course, this should lead to lower fees for investors. At SignalRank, our long term intention is to offer our index at 0.5% per annum as a publicly-traded product (whereas DXYZ’s expense ratio is 6.8% to average net assets and Ark charges 2.9%).
What are the potential structures available?
In the US, investors tend to think of Business Development Companies (BDCs) in the rare moments that they are thinking about listed venture capital structures at all.
Established by legislation in 1980 to counter the decline in capital availability to SMBs in the 1970s, BDCs are listed entities which enable retail investors to allocate to small and medium-sized businesses. They are somewhat akin to Real Estate Investment Trusts (REITs) in that they enjoy a pass-through tax status, as long as 90% of taxable income is distributed to shareholders. Indeed, it is the high dividend yield of BDCs that appeals to investors.
The best known BDCs these days (such as Ares Capital) are focused on private credit, not equity. This is primarily driven by the fact that the investors are yield seeking, not growth orientated. Also, 70% of total assets of a BDC must be invested into “eligible portfolio companies” with valuations of <$250m. This makes the structure unviable for VC investors in a world where AI companies can raise at $1bn valuations pre-revenue.
This leads us to the debate between DXYZ and Ark Ventures, as the other main options for creating a listed venture capital product for non-accredited investors are an exchange traded closed-end fund (ETCEF, DXYZ) and an interval closed-end fund (ICEF, Ark).
ETCEFs are publicly traded investment funds with a fixed number of shares issued at an IPO. Shares trade on stock exchanges like equities. ICEFs are hybrid investment vehicles that provide periodic (quarterly or semi-annual) liquidity windows to investors.
In an attempt to rebuff DXYZ’s attacks on X, Ark wrote this helpful explainer on the difference between ETCEFs and ICEFs. There are essentially three key differences:
Liquidity: ETCEFs are fully liquid as investors can simply sell their stock daily through exchanges, whereas ICEFs have limited liquidity where investors need to be mindful of redemption policies.
Valuation: ETCEFs can deviate from NAV (trading at premiums / discounts to NAV) while ICEFs track NAV.
Taxation: both ETCEFs and ICEFs can qualify as Registered Investment Companies (RICs) for taxation purposes, meaning substantially all gains can be distributed to investors. Yet DXYZ does not meet the required standard as a RIC, and is subsequently treated as a C Corporation subject to taxation at the fund level (with net gains distributed to shareholders).
The goal of Ark’s article was to argue why Ark selected the ICEF structure, but, to this reader at least, it appears to actually have the exact opposite effect, making the ETCEF appear to be more attractive. Indeed, SignalRank itself intends to become an ETCEF.
This is the lay of the land today. There is a dream to create private asset ETFs in the future. No-one has cracked this yet, largely because of the immediate liquidity and daily valuation requirements of an ETF. The closest approximation is the Frankenstein private credit ETF structure recently created by Apollo & State Street. This is really a headfake though, as only 15% of the assets can be in illiquid holdings, and daily liquidity is essentially underwritten by Apollo. Nevertheless, it appears that the focus of future innovation will be around this area.
If NAV is not the driver, what are valuations based on?
It’s hard to shake off the feeling that DXYZ’s valuation is based on vibes. As at 30 September 2024, DXYZ’s NAV was $58m (although SpaceX raised its valuation in December 2024 by 65%, implying a NAV of $72m). As at 19 December 2024, DXYZ’s market cap was $653m. 11x NAV (or 9x post SpaceX bump). WTAF.
It is particularly intriguing as many of DXYZ’s positions are via SPVs and forward contracts (with unknown economics). The NYT wrote this piece on the potential pitfalls of DXYZ’s approach here, including citing Stripe’s warning that “Stripe, which is in the DXYZ portfolio, forbids forward contracts and has said such deals are void”.
If we are seeking to apply logic, we can think of two potential explanations for DXYZ’s valuation. One is the argument above that DXYZ is a proxy for SpaceX, where the public markets are saying that SpaceX is hugely undervalued in the private market. The second, which we like at SignalRank, is that there is overwhelming demand for high quality private assets from public market investors. If you have any other ideas as to what is driving this, we’re all ears…
DXYZ is currently seeking to raise additional capital. It is challenging to see how this level of premium to NAV sustains itself in the event that additional capital is raised.
In fact, it is unusual for an ETCEF to trade at a premium to NAV in any event. Most listed VC entities trade at a discount to allow for the illiquidity of the portfolio. Outside of the US, where investors typically are less growth minded, the discount is even steeper (see Molten Ventures or Kinnevik).
It should be possible for a ETCEF to trade at a premium to NAV by demonstrating predictable cashflow. It is for this reason that we like the idea of creating programmatic secondaries after a fixed period of time for each annual cohort of investments. This would signal to the market somewhat forecastable cashflow. Cash would be recycled into the next cohort of investments.
The logical conclusion of having a ETCEF with predictable cashflow would be to value such an instrument using a DCF. Alas, this is almost certainly not where the market is today (preferring NAV-based valuations).
Indeed, we philosophically think of SignalRank as a FinTech which has a data-driven approach to acquire assets, not a fund. In this way, we are more akin to Carvana, Opendoor or SoFi, except that we are buying potential unicorns instead of cars, houses or personal loans. These businesses have low single digit margins BUT they all trade at a multiple of book value because they have a high velocity of capital, turning over their books multiple times per year.
If an ETCEF could demonstrate a higher velocity of capital (with programmatic secondaries), surely a similar logic should apply? Would this type of fund therefore not trade at a premium to NAV?