The period between the bursting of the dot-com bubble in 2000 and the financial collapse of 2008 had a profound effect on the investment philosophy of the Ontario Municipal Employees Retirement System (Omers). While still intrigued by the underlying investments within its venture capital pool, the large Toronto-based pension plan’s fondness had waned for the funds and the venture model as it stood at that time. Despite the rosy economy, the value of investments remained flat or declined, the general partnership/limited partnership model led to economic misalignment, and returns were generated only after ten years or more.
In 2008, Omers announced it would no longer invest in venture funds; however, it still wanted to stay in the venture capital universe. Enter the pension fund’s new Omers Ventures division, which cuts out the venture capital fund middlemen and invests directly in a variety of companies, largely start-ups. Launched in October 2011, Omers Ventures has been able to accumulate a portfolio that “I would have never imagined at this time,” says John Ruffolo, the division’s CEO. Companies on the pension fund’s investment roster include Kitchener, Ontario–based electronic education software company Desire2Learn and Vancouver-based construction e-commerce site BuildDirect. But perhaps the biggest name to get an injection of funds from Omers is Vancouver-based social media management tool creator HootSuite, which in March 2012 got $20 million from the Canadian pension fund. About a month ago Montreal–based PasswordBox, a site that manages and protects users’ online passwords, became the latest start-up to secure venture capital from Omers, which led a $6 million round of funding that also saw a number of Silicon Valley investors chip in, including Lee Linden, head of Facebook e-commerce.
Ruffolo, Deloitte’s former global tax leader and Canadian industry leader for the accounting firm’s technology, media and telecommunications practice, was tapped as the venture capital funding division’s CEO. Presently the Omers Ventures team includes 15 people in addition to Ruffolo. He expects to grow that number to 18 over time, with no set deadline.
One of the most important reasons for creating Omers Ventures, says Ruffolo, was the fact that venture capital–backed investments, especially in Canada, were often taking longer to incubate and produce returns than the pension fund was prepared to handle. That said, Omers Ventures’ present investments are being made with long-term returns in mind. Real returns aren’t expected for at least seven years after an investment’s inception. There have been early qualitative signs of success, however. “After 18 months of investing in these companies, all of our late-stage investments have been performing ahead of our thesis when we first invested in them,” says Ruffolo.
Omers Ventures selects its investment targets by researching new markets and performing “very rigorous due diligence” on the companies it believes are best positioned to capitalize on large market opportunities, notes Ruffolo. The group divides its venture capital investments into three parts: one third seed, one third early-stage and one third late-stage. By doing so, explains Ruffolo, the board of Omers Ventures is willing to take bets on some of the early-stage venture capital opportunities while still ensuring a strong risk-adjusted profile.
At the moment, Omers Ventures is taking a decidedly conservative approach to the role of direct venture capital in its investments. Presently, the venture capital division accounts for some C$400 million ($376.2 million) of Omers’s C$60 billion portfolio. Ruffolo says that although there is no official target, the eventual goal is to have C$1 billion in venture capital. “The cycle will take us about ten years to deploy all of that,” he explains. “What will start to happen is that investments you’ve invested in for ten-year periods would start to realize, and in essence you redeploy realized assets. In effect it becomes an evergreen fund.”
Omers is the only pension fund in Canada that has ceased investing in any venture capital funds and started making direct venture investments. At Omers, there is an enterprise-wide focus on direct ownership and active management of assets, which has grown from 70 percent in-house at the end of 2008 to 88 percent at the start of this year, with the long-term goal being 95 percent. “Although [as a pension fund] we were the first to adopt this model, we will by no means be the last,” says Ruffolo, hinting that global pension funds may be taking an interest in direct venture capital investing.
Victoria Ivashina, an associate finance professor at Harvard Business School and a fellow of the National Bureau of Economic Research, is the co-author of a report titled “The Disintermediation of Financial Markets: Direct Investing in Private Equity.” She notes that the direct model of investing in venture capital is rare and has a better fit with large and sophisticated pension funds.
“Large funds and government sovereign wealth funds are more inclined to pursue something like that,” she explains. “For them, it makes more sense than [for] a smaller pension fund pursuing direct investments, because there is a nontrivial requirement in terms of resources.” Ivashina adds that in the U.S. there are restrictions against state pension funds acquiring the resources needed to operate a direct investment program.
One point that emerges clearly from Ivashina’s research: Solo or direct investments — that is, without intermediaries — do better than co-investments. “Growth investments and investments in industries that have high research and development budgets do very poorly when completed on their own, versus transactions that are completed with a traditional private equity model,” she explains.
Ivashina says that while direct investing is not for everyone, it certainly can work for funds like Omers, which has fewer constraints than its U.S. counterparts. “You need to have a certain level of independence,” she says, “because you need people who can execute, follow up and sit on boards.”
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