Venture Capital invests today in the businesses of tomorrow but has long been out of the reach of retail investors with high minimum investment levels. But with a new generation of funds, VC is becoming more accessible.
Jonny Blausten, founder and CEO & Daniel Lehmann, founder of Sprout. a Venture Capital fund platform, explain the opportunities afforded by the asset class.
With the ongoing economic downturn and inflationary pressures, it has become increasingly challenging for investors to identify investment opportunities that keep up with the real value of money, let alone outperform it. In search of inflation-beating returns, some opt for unproven, risky asset classes and fast returns, whilst others seek to smooth the volatility through longer-term investments. In a turbulent market, it can be difficult to decide which path to take.
One of the advantages of Venture Capital (VC) is that it is a proven asset class that may offer a solution to this dilemma.
Private investor portfolios lack diversity
Typically, private investors’ portfolios are reliant on stock market-linked ISAs and pensions and are overly exposed to market sentiment. Investors may therefore seek diversification – VC funds have consistently performed strongly, with top quartile funds returning more than 35% annually for over a decade, according to Pitchbook.
These funds invest in undiscovered private businesses before they potentially become household names, building diversified portfolios of 20 or more companies to spread investment risk. There’s a reason why sophisticated investors including family offices typically allocate a significant portion of capital to VC, according to Silicon Valley Bank UK.
However, VC remains largely inaccessible due to the arbitrarily high minimum investment threshold set, typically at least GBP1m per opportunity, and in many cases GBP5m or more. VC fund opportunities, and their associated returns, have therefore typically been reserved for a minority of investors.
Venture Capital funds growth potential
Statistics show that 90% of start-ups fail and just 0.00006% become unicorns [the term ‘unicorn’ refers to a privately held start-up company with a value of over USD1bn. It is commonly used in the venture capital industry. Unicorns are very rare]. If investing into early-stage companies directly, the chances of achieving desired returns increase when investing across a portfolio of 20 or more start-ups, rather than one or two.
Venture capital firms do just that, screening thousands of opportunities and building a portfolio typically comprising 20 or more investments, giving themselves the best chance of delivering outsized returns. Dedicated teams of experts and analysts assess market trends to find these opportunities Private investors often rely on instinct and personal network to identify great start-ups.
Despite perceived insight or expertise, the truth is that this is like finding a needle in a haystack. The best start-ups have their pick of institutional investors, leaving private investors struggling for access to the very best opportunities. Private investors and crowd funders also likely acquire shares with the worst terms, particularly as institutional investors seek to negotiate certain preferred terms. In a downside scenario such as a business failure, as illustrated recently by Thread Inc. [an AI-driven online personal styling platform that collapsed at the end of November. It was funded partially by VC and took in small investments, but went into administration and its IP was acquired by high-street retailer M&S LON:MKS], private investors are left out of pocket.
Diversification is an advantage Venture Capital funds can build into their portfolios meaning that those funds invested in Thread likely lost less than 5% of their overall portfolio value, whereas many private investors will probably have concentrated a significant portion of their angel portfolios in one business.
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The advantage of Venture Capital funds
Many private investors looking to unlock the benefits of investing in private companies may errantly turn to angel investing. Despite best intentions, private investors must ask themselves whether they are able to identify and access the best possible opportunities and build a balanced portfolio sufficient to mitigate the risk of failure. Unlike private individuals, VC funds are exclusively focused on sourcing and executing the best possible deals.
In addition, private investors often focus their attention on more familiar consumer brands rather than B2B companies such as enterprise software or deep technology. However, businesses in consumer and retail markets typically find it harder to reach significant scale (GBP1bn plus valuations) and are often hit hardest by economic downturns, meaning private investors are often exposed to more risk and less upside than a typical VC fund.
It is logical to back the experts, rather than going it alone. Clues to future success can be found in the successes of the past. VC funds that have delivered consistently strong returns are best positioned to do so again.
Level playing field
Despite macroeconomic conditions, good businesses with strong fundamentals and credible founders are justifiably being funded. If anything, this vintage of VC funds will benefit from investing at lower valuations during the trough of the economic cycle, with the typical seven-to-10-year investment period giving the market, and by extension valuations, sufficient time to recover before realising a return.
So, why shouldn’t all eligible investors have access to these funds?
We believe that they should.
