Many funds in recent years have taken advantage of a strong US dollar to increase their capital allocations overseas. According to the Global Private Market Trends report which explores the forces shaping VC ecosystems, half of AI VC and growth deals are in companies based outside of North America.
First Citizens Fund banking serves venture capital funds offering financial services, strategic solutions, and a full suite of banking products. We are often asked the question:
“Should we hedge the foreign currency risk of our investments?”
There is no one-size-fits-all answer. Whether it is wise for a given fund to hedge depends on a range of factors, including the asset type acquired and the relative size of the exposure.
We have developed a four-point checklist to help assist clients, as they make this important strategic and risk- based decision. Consider each item on the checklist in sequence. It is considered a best practice to align the hedge with the investment in duration and amount. The checklist helps determine this alignment.
The VC 4-Point Checklist can help with the FX hedging decision
- FX exposure of portfolio company
- Materiality
- Likelihood of exit
- Exit timing: How much visibility and/or control do you have on the timing of the exit?
FX exposure of portfolio company
When investing internationally, it’s critical to recognize that FX exposure isn’t simply determined by where a portfolio company is domiciled. A company based in a foreign country may carry no real FX risk if its revenues and expenses are all in the fund’s base currency—for example, a Singapore-based startup billing and spending in USD. Conversely, a company may appear “de-risked” if it plans to IPO in the fund’s base currency, but if its operations are entirely in foreign currency, FX exposure remains fully intact—the IPO just shifts valuation optics, not the underlying currency risk. FX exposure often hides beneath the surface, and thorough analysis of a company’s functional currency, cash flows, and financial architecture should be a standard part of every VC’s international investment checklist.
Materiality
Two primary factors determine the materiality of potential currency-related losses: the size of foreign holdings and the potential impact currency fluctuations could have on them.
To gauge how the size of foreign holdings affects their materiality, measure the percentage of the fund’s net asset value made up of assets denominated in foreign currencies, broken down by currency. To measure potential impact, consider the loss that could result from an adverse move in the foreign currency. This projection varies by currency; it can be based on historical patterns or currency option prices, and generally assigns a level of probability to projected outcomes.
The combination of size and impact determines materiality. Consider the following hypothetical example:
A $200 million fund invests $185 million in dollar-denominated assets and the remaining $15 million in euro-denominated assets. When foreign exposure is less than 10% even a material move in FX has minimum impact to overall fund performance. A 20% depreciation in the euro—which would be large by historical standards—would have only a -1.5% impact on the fund’s performance.
However, if the foreign assets outperform and become a majority of the fund holdings (30%), a 20% depreciation now resembles a 6% drag on overall performance - a meaningful impact that could influence fund rankings or investor perception.
A fund may meet the materiality threshold when:
- both the size of a foreign-denominated position and the potential currency impact on performance are significant in their own right
- the potential loss exceeds the fund’s risk tolerance.
Likelihood of exit
Earlier-stage companies are inherently riskier with valuations that can swing drastically. The uncertainty around an individual investment’s likelihood of exit can make it difficult for venture capital funds to hedge currency risk efficiently. The hedge contract must be supported with collateral or a credit facility at inception and settled with cash or currency at expiry, regardless of the investment performance. If the exposure fails to materialize, there is a potential for residual obligation on the hedge that would not be offset by the investment inflows.
Suppose a venture capital fund invests in 100 start-up technology companies, 90 in the US and 10 in Europe, and the fund expects 5 of the 100 to be successful. If its expectation is correct, and all firms have the same probability of success, the fund has about a 40% chance that at least one of its successful investments will be from Europe. As a result, the fund has significant odds of exposure to the euro.
Considerations related to a successful exit are clearer for growth capital funds that invest in companies further along in their life cycle and for private equity firms investing in relatively mature companies. These funds historically have more certainty around future valuations than venture capital funds do, and greater visibility into exit timing as well. Funds of these types may support having greater certainty about whether FX exposure will materialize, making them better suited to active hedging strategies.
Exit timing
FX hedging enables funds to lock in a predetermined rate at which foreign currency will be converted to the home currency, typically the US dollar for US-domiciled funds, at a predetermined date. The hedging instrument used represents an obligation to an amount and to a time. Visibility of exits is crucial to the efficacy of a risk management strategy.
Funds that focus on seed, series A and series B investments may have little visibility into their exit timing. Conversely, later-stage investors, fund-of-funds investors and credit funds that lend directly to portfolio companies have greater visibility into the timing of their exits. Likewise, funds with a strong presence on a portfolio company’s board have input and insight into both the type of exit and its timing.
All else being equal, greater visibility into a potential exit may make hedging currency risk more viable. However, there are situations in which it may also be appropriate to proceed with hedging despite exit date uncertainty. Shorter-dated hedges may be used and rolled as needed. Purchased options are also well-suited to deal with notional amount and timing uncertainties. For additional guidance on this important implementation detail, please refer to our FX Risk Advisory white paper: Multi-year versus rolling FX hedging
The bottom line
This checklist is meant to serve as a practical framework to help VC firms think more clearly about FX exposure and how to approach managing it. It’s not a one-size-fits-all solution—checking all the boxes doesn’t automatically mean you should hedge, and missing some doesn’t mean you shouldn’t. Every decision should be evaluated in the context of your firm’s risk appetite, return expectations, and overall strategy. At SVB, our FX team is here to partner with you in that process—bringing clarity to complexity and helping you make informed, confident decisions as you navigate international investing.
Contact us
If you would like your dedicated FX sales contact to assess the FX risk of your fund, please reach out to GroupFXSalesGFB@FirstCitizens.com.
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