Maximising the value of your capital and finding ways to make your money work as hard as possible should be the key goals of every investor. Against this focus it is always important to balance risk with reward. This means you should seek excellent returns but ensure you won’t lose your shirt if events don’t go as planned.
Which is easy to say, but how do you achieve this?
Investing in a venture capital fund can give you unique access to a portfolio of high-growth potential opportunities that could generate substantial returns over time. It also gives you a business partner who have their own money in the game and who can provide the essential expertise to keep risk to the minimum. Ultimately, you are teaming up with a team of seasoned professionals who have the same goal as you do; outstanding returns with acceptable risk exposure – a Goldilocks result.
Sounds interesting? Read on to find out more.
What is venture capital?
Amid the complex, often overlapping systems and techniques that shape the world of modern investing, it is easy to confuse one investment strategy with another. So what exactly is venture capital and how is it different from other forms of investing?
Venture capital (VC) is a type of private equity financing that investors provide to startup companies and small businesses that are projected to have high-growth potential. In exchange for their investment, venture capitalists typically receive an ownership stake in the company. As well as high-growth potential businesses, most venture capitalists will also invest in other alternative investments, such as commodities, real estate, cryptocurrencies, rare art, antiques and collectibles.
How does venture capital work in business?
Venture capital functions as a critical source of finance for startups and early-stage businesses. As well as providing their own capital, VC firms raise funds from institutional investors, corporations, family offices and high net worth individuals. These funds are pooled into a venture capital fund, which is then deployed into promising startups, projects and other alternative investments.
The process typically begins with deal sourcing, where venture capitalists actively seek out investment opportunities through various channels such as networking events, referrals, and industry research. Once a potential investment is identified, due diligence is conducted to assess the opportunity’s viability, market potential, team, and other crucial factors. The rejection rate is very high. On average, only 1 in a 100 potential deals receive full funding.
Post-investment, venture capitalists play an active role in supporting the company, providing not only capital but also strategic guidance, mentorship, and access to their network. The ultimate goal is to achieve a profitable exit from the investment on a pre-determined timeline. This may happen through acquisition by a larger company, via an initial public offering (IPOs), by selling the invested asset (such as real estate), or through a buy-back by the project founders.
Venture capital advantages and disadvantages
Investing in a venture capital fund has unique pros and cons:
Pros:
- Potential for high returns: Venture capitalists invest in opportunities that carry high-growth potential. Successful investments can yield significant returns, often outperforming traditional asset classes like stocks and bonds.
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- Diversification: Investors gain access to a diversified portfolio of opportunities – businesses, projects, commodities, cryptocurrencies etc. Diversification helps to mitigate risk.
- Access to expertise and network: VC firms employ experienced investment professionals who have expertise in identifying and nurturing high-potential opportunities. Investors have direct access to their knowledge, network, and resources.
- Alignment of Interests: VC firms typically invest their own capital alongside that of their limited partners. This alignment of interests ensures that the VC firm is motivated to generate attractive returns for its investors.
- Support for portfolio companies: VC firms provide more than just capital; they also offer strategic guidance, operational support, and mentorship to the opportunities in their portfolio. This support can help portfolio companies to navigate the challenges, accelerate their growth, and maximise their potential for success.
Cons:
- Elevated risk: Venture capital investments typically carry higher risk. Investors could lose some or all of their investment if the portfolio underperforms or fails to deliver any returns.
- Illiquidity: VC investments are typically illiquid. Investor capital can be tied up for an extended period. Unlike publicly traded stocks, which can be bought and sold on an exchange, VC investments often have limited opportunities for liquidity until the portfolio is liquidated or invested companies exit through an IPO or acquisition.
- Fees: VC firms typically charge management fees and carry fees. These costs can erode investors’ net returns over time.
- Passive investment: Investors have limited control over the selection and management of individual investments.
- No guarantees: There are few ‘sure things’ in investing, and while VC investing has the potential for high returns, there is no guarantee of success. Even experienced VC firms with strong track records can experience failures, and past performance is not necessarily indicative of future results.
What you need to know before you partner with a venture capitalist
When investing in a VC fund, investors rely on the investment firm to pick successful opportunities on their behalf. As a result, the criteria for evaluating a fund investment are different from those applicable when evaluating an investment in a single business, and there are specific factors investors should consider. These include the investment firm’s investment thesis, team, reputation, and the fund’s investment terms and structure.
Key points to consider:
Investment thesis:
Most VC funds have a clearly defined investment thesis and strategy that the fund follows to generate returns for its investors. The thesis will typically identify the sector, stage, and geography of target investments. You need to know:
- Sector: Is the fund sector specific or generalist?
- Stage: At what stage in a company’s lifecycle does the fund invest?
- Cheque sizes: What are the average ticket sizes the fund’s investments?
- Portfolio size: What is their target portfolio size?
- Follow on/reserves: Does the fund reserve some capital for follow on investments or prefer to build a larger portfolio?
Team:
Investment firms that manage VC funds can come in many shapes and sizes. Some firms launching their first fund may be run by one partner with relevant experience. Full-scale firms with multiple active funds can have hundreds of employees across investment, BD, admin, finance, and all the other functions that you’d expect from a business of that size. Either way, your investment strategy should decide what type of firm you wish to invest with. To determine this you need to ask:
- Experience: What is the experience of the fund manager?
- Deal origination: How is the team originating a quality deal flow?
- Advisers: Does the team have advisers or an entrepreneur in residence working with them with additional sector expertise?
- Fund series: i.e. Are they first time fund managers or is this fund V…?
- Performance metrics: Have they published performance metrics for previous funds such as MOIC or IRR?
- Value add: What specific value do the funds promise founders?
- Fund team size: How many investors are on the team?
VC fund structure and terms:
It’s important to review the fund’s structure and terms before investing, as these directly affect the timeline to returns. Questions to ask include:
- Lifecycle: what is the fund investment period and exit timeline?
- Drawdowns: What is the fund drawdown schedule?
- Fees: What are the management fees?
- Distribution waterfall: How does the fund distribute returns to investors?
- GP commitments: Are partners investing their own capital to give them skin in the game?
- Lead investors: Who is backing the fund already?
Note that you should always complete your own research and due diligence beyond what is listed above. Investing in venture capital funds can generate good returns but they also carry more risk. Only eligible investors can invest. Never invest more than you are comfortable with losing.
Why partner with the Matt Haycox Group
The Matt Haycox Group is an owner of, and investor in, a group of businesses in multiple market sectors. With exposure to high growth tech companies, and more traditional, asset backed businesses with strong cash flows, our portfolio is balanced for both consistent income and extreme capital growth. We also have skin in the game; typically investing our own funds first to ensure each investment is sound – kicking the tyres to reduce the risk of investing in a lemon.
At the end of the day, investing is all about experience, knowledge and finding diamonds in the rough. Our track record speaks volumes in this regard.
If you are interested in investing in alternative investments and would like a private consultation, please contact us to schedule a call. You can also view a range of exclusive alternative investment opportunities with The Matt Haycox Group.