The Fuzzy Borders Of Sovereign Wealth


Managing Partner and cofounder of Scale-Up VC, a venture capital firm, and West Coast Equity Partners, a private equity firm.

Sovereign wealth in venture capital is nothing new. Elizabeth I invested in Francis Drake, and he netted a return of an estimated 4,600%, which incidentally inspired the founding of the East India Company. This is arguably history’s first unicorn. (Getting your Series A funding from a monarch really puts the sovereign in sovereign wealth.)

Sovereign wealth also makes a lot of sense. Individuals invest for any number of reasons: saving for a rainy day, raising their standard of living and generating a cycle of reinvesting gains toward a sustainable passive income. Countries similarly invest for the same reasons. Perhaps that is why sovereign assets under management almost tripled from about $3 trillion in 2007 to about $8 trillion in 2020. Each of those figures doubles again if you include public pension funds.

Still, sharing a cap table with sovereign wealth can be risky, and the risks tend to be political. If the country behind the money irritates a good portion of the world, it could make things awkward at the next funding round when their money is either no longer accessible or accessible but toxic. That much is obvious, especially now.

What’s less obvious is that such risks apply differently to different sources of sovereign wealth, and there is a large pool of what call pseudo-sovereign wealth that lies outside conventional definitions but is subject to similar risks. Let’s consider what lies within and beyond the fuzzy borders of sovereign wealth.

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What Is Sovereign Wealth?

All definitions of sovereign wealth that matter, whether the Santiago Principles of the International Forum of Sovereign Wealth Funds or the Organisation for Economic Co-operation and Development, share a common criterion: state ownership. Semantically speaking, that criterion makes sense. Sovereign means to have supreme political power, which means it applies to states.

But semantics aren’t the only factor to consider when defining terms in finance. Other criteria, like returns, regulations, organizational structure or participants can play important, even decisive, roles. For the purposes of this analysis, the decisive criterion is risk versus benefit. Money that profits from the same benefits and that is subject to the same risks as real sovereign wealth can be, for all intents and purposes, considered sovereign wealth too.

One important benefit of sovereign wealth is political cover. It would surprise no one if a certain industry or enterprise with sufficient clout pressured the political machine for favorable regulation or less regulation. That’s a big idea behind public choice theory. It’s essentially lobbying. Now, what if the government itself, as an investor, were the beneficiary of an industry or enterprise’s growth? Might a government agency use a lighter touch on an enterprise in their sovereign wealth fund’s portfolio?

Even bureaucrats have a survival instinct. Some department manager is likely to make an informal phone call before imposing a penalty. A cynic might even suggest that some ventures facing regulatory pressure court sovereign wealth investment for precisely such reasons.

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Another important benefit is access. Sovereign wealth funds tend to be big, and they might be able to convince a minister or undersecretary to make a phone call and set up a meeting. Even the best general partnerships of the biggest funds would find that handy on occasion.

The corollary is that sovereign wealth is also subject to political contamination. Sovereign wealth funds often and understandably get lumped together with their regimes. Investors who gripe about SEC regulations should try UN sanctions, which is a risk faced by sovereign wealth funds.

Of course, such risks vary with how powerful and globally integrated the countries involved are. Weak countries can’t or can’t credibly sanction powerful countries’ sovereign wealth. Another important question is transparency. Risks shrink with the likelihood of getting caught, and sovereign wealth funds vary greatly in terms of transparency.

Pseudo-Sovereign Wealth

There is a large but unquantifiable amount of money in the world’s markets that is not owned by governments but that does benefit from the same kind of political access and cover enjoyed by official sovereign wealth.

For example, a prime minister could be a member of a family conglomerate covering construction, telecoms, media and banking. Or, in order to avoid a conflict of interests, a leader could abdicate ownership and control over his shipping company by giving it to his sons. But pseudo-sovereign wealth goes beyond family ties. It could also include money possessed by those who might have helped an important person in a tough spot, say, by buying votes for their re-election.

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Fascinatingly, political access and cover can actually become liabilities in such cases. If, as often happens, the story gets out about how a deal got done, who opened which doors and who covered for which mistakes, a banal instance of cutting corners can turn an entire deal or fund toxic.

Don’t Fret, Check

The point is that sovereign wealth extends farther than formal definitions and official sovereign wealth funds. Sovereign wealth brings benefits and risks, and they apply to quite a bit of investment capital. Because Sovereign wealth goes beyond state money, any investment that can benefit or suffer from government ties— even faint, informal ones—counts. All of us venture capitalists probably share at least one cap table with pseudo-sovereign wealth.

The best way to deal with this, as so often, is to do your homework. Not all sovereign wealth will be as obvious and unproblematic as, say, Norges, Temasek or the Alberta Investment Management Corporation. Find out who else is involved in a deal and who is in their networks. One way is to ask for the benefits: What connections do they bring? What doors can they open? What problems can they solve? And then, in private, reverse the equation. Every asset is a liability somewhere else. Every informal favor is a risk on a bad day. You can’t overdo due diligence, especially when it comes to sovereign wealth.


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