Geographic focused funds have been taking the investment world by storm over the last 5 years. With their focus on non-coastal companies, these funds promise better valuations, but is that really the case? As an institutional investor, it’s important to understand if these claims hold true. So, after doing some digging, I’m here to shed light on whether geographic focused funds are truly valuation sensitive.
Fundraising decks for these funds always mention better valuations as one of the core investment benefits. However, my research indicates otherwise. Since geographic regions have a more limited supply of companies to choose from, they’re more eager to get allocations in the best deals, even if that means paying higher valuations. This makes them a price taker, not a price maker. The idea of getting better valuations might sound good on paper, but the reality is different.
I came across a promising company, but passed because of the steep price. To gauge interest, I contacted a few geographic funds outside of Phoenix and proposed the same terms. The response was positive, but I questioned what would happen if the next round was flat. The investor replied, “At least I was in the deal.”
The reasoning behind this makes perfect sense if your thesis is centered around securing the best deals in your respective geography. It’s in the investor’s best interest to maximize their allocations, even if it means paying higher prices. To reduce risk and secure a return, they may have to make deals with less attractive terms.
My own investing philosophy has evolved over the years, and I appreciate Howard Lindzon’s words that if you like everything about a company except the valuation, you need to suck it up and pay it. But at this point in my career, I cannot get there. For me, seeing meaningful step-ups in valuation between rounds is imperative. It’s not just about making an investment; it’s about getting the best returns on that investment for the risk. I don’t invest in Silicone Valley Companies but my geographic focus is everywhere else.
In conclusion, geographic focused funds might claim to be valuation sensitive, but in reality, that’s not the case. The need to find the best deals and secure allocations in a more limited supply of companies often leads to higher valuations. This is no different than investing in Silicone Valley. Allocation trumps price when there is a limited supply.
