By Peter Mastrantuono
U.S. venture capital assets under management have risen to $444 billion as of the end of 2019, up from $237 billion in 2010, according to the National Venture Capital Association, a leading industry group. Long the domain of institutional investors, pensions and affluent investors, venture capital (VC) investment opportunities are slowly becoming available to Main Street investors.
What is Venture Capital?
Venture capital represents an important source of funding for early stage companies. These monies may be used as early as the “idea stage” to pay for research and development, to fund the set-up of relevant operation, product development, marketing, manufacturing and sales functions for the company or even pay for business expansion as the company’s business grows.
It is important to understand several key distinctions between VC investments and publicly traded stocks. The key differences of VC investments are that they:
- Are illiquid investments, meaning that such investments cannot be easily (or at all) converted into cash;
- They must be viewed as very long-term in nature (usually a minimum of 5-8 years)
- Their stated value may not match the value that a typical public exchange of buyers and sellers might attach to the company; and
- The objectives of VC investors and company founders may be at odds.
Why Venture Capital?
There are two compelling reasons why investors are attracted to VC investing.
The primary reason is the potential to earn higher rates of return than what may be earned through investing in public companies. According to Cambridge Associates, as of March 31, 2020, its index of venture capital investment pools outperformed the S&P 500 over one, three, five, ten, 15, 20 and 25-year periods—often by a wide margin. For instance, over the last three years the Cambridge Associate U.S. Venture Capital Index generated a 13.96% annualized rate of return, while the S&P 500 gained just 5.10% on an annualized basis over the same period.
Venture capital investments can also improve portfolio diversification since they have low to moderate correlations to other key asset classes. For example, according to Invesco, a large asset manager, VC funds have a slight negative correlation to large cap equity, high yield bond and aggregate bond asset classes.
VC Investing Risks
Investing in new companies and new ideas is high risk. More companies fail than succeed. Of course, this risk can be mitigated somewhat by investing in a diversified VC fund. In selecting the right fund investors of all sophistication levels need to be concerned about the size of the fund (too large of a fund will negatively impact performance) and cognizant of the investment stage that a fund will focus on, e.g., seed stage, early stage or late stage since each will come with a different return/risk profile.
Moreover, the disparity in performance between top performing VC funds and bottom performing ones is perhaps greater than with any of the more traditional asset classes. This makes it crucial that investors seek funds that have access to the best managers in the VC space.
VC Becomes More Accessible
There are a number of ways that ordinary investors can access venture capital investments, from publicly traded funds to independent crowdfunding platforms. Whether they make sense for an individual’s long-term goals and risk tolerance is an important discussion to have with an experienced financial advisor. If VC investing is deemed appropriate, he or she can help identify good investment candidates to consider.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.