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Hedge fund money going to venture-backed startups is skyrocketing

The amount of venture capital startup companies are raising from hedge funds, mutual funds and others beyond the traditional venture capital community is skyrocketing, fueling fears of another tech bubble.

While venture capitalists poured $11.3 billion into startups in the first quarter, up only 11% from a year ago, non-traditional funds invested $6.4 billion, a 167% increase, according to a report on Tuesday from CB Insights, which tracks the market. Two years ago, the outsiders contributed less than $1 billion.

Hedge funds and mutual funds have been getting more involved in venture capital investing as fast-growing startups stay private longer. Some also blame the Federal Reserve's low interest rate policy, which may be prompting funds to take more risk to achieve acceptable returns.

The flood of hedge fund and mutual fund cash is helping push up the valuations of private companies, a clear trend in the CB Insights data as well as earlier reports on the growing number of so-called unicorns, or venture-backed firms valued at $1 billion and up. There were seven companies that reached the $1-billion-or-higher valuation level in the first quarter, CB Insights reported, after 24 gained that status in all of 2014.

Non-traditional sources of venture capital hit $6.4 billion in Q1 2015. (CB Insights)
Non-traditional sources of venture capital hit $6.4 billion in Q1 2015. (CB Insights)

While many unicorns are well-known companies like Uber and Pinterest, the newly designated unicorns in the first quarter included much smaller companies such as Nextdoor, a neighborhood-focused social network, the name-that-tune service Shazam and, a clothing e-commerce site, according to data from Dow Jones VentureSource. More than 80 companies in total are now valued at $1 billion or more, Fortune Magazine reported in January in a story titled "The Age of Unicorns."

All that private funding, especially coming at a time when a the market for initial public stock offerings seems quiet for tech companies, is fueling fears of another investing bubble.

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“So why is this bubble far worse than the tech bubble of 2000?” Mark Cuban asked on his blog last month. “Because the only thing worse than a market with collapsing valuations is a market with no valuations and no liquidity.”

Venture capitalists, including Bill Gurley of Benchmark and Todd Dagres of Spark Capital, have also warned of an inflating bubble in private tech companies. Still, the fact that the companies are private and the amount of capital they have raised can be measured in the tens of billions, not hundreds of billions, of dollars, should limit the damage if the bubble pops.

In fact, the public stock market has acted as a check on high private market valuations in some recent cases. Companies including Hortonworks (HDP) and New Relic (NEWR) went public last year at prices that valued the companies at close to or even less than the valuations in their last round of venture capital funding.

Some of the most active non-traditional investors include mutual fund firms T. Rowe Price (TROW) and Fidelity Investors. Prominent hedge funds include Lee Ainslie's Maverick Capital, Philippe Laffont's Coatue Management and Charles Coleman's Tiger Global Management.