Why invest in venture?

Venture Capital, which is the investment of money into early-stage private company equity, has seen a tremenous amount of growth over the last few decades. Not only has more money been allocated into venture capital by those who have long been investing, resulting in significantly bigger funds. But a growing number of investors who did not previously invest in this asset class are beginning to make sizeable allocations to venture. Some of this comes in the form of direct angel investments. Some is coming through participation in a growing range of emerging funds. As a result, there are many more funds, angel investing groups and better ways to engage with venture capital than ever before.  We explain why these trends are happening and whether venture investing might be right for you.

Better Investment Returns

Dave Swenson, the legendary manager of the Yale Endowment, outperformed all his peers in part by allocating far larger portions of his funds to private equity and venture capital. These sectors can produce extraordinary returns, unlike the more traditional asset classes like stocks and bonds, which generate returns that mirror overall growth in the market. Swenson inspired a generation of fund managers to seek higher returns (alpha) through asset classes like venture capital, hedge funds and private equity and such allocations have crept up as a larger percentage of institutional funds, from a mere 15% back in the 80s, to as much as 85% at the Yale endowment at the start of this decade.

Greater Access through Technology

Up until recently, venture capital has been the exclusive playground of large institutional investors, like university endowments, pension funds and foundations. A minimum of $5 million to participate in a premium firm was not unusual. Even the top 1% of individuals, with over $10 million in net worth, could not afford to play. Fortunately, those days are long gone. Over the last decade, an explosion of new funds has improved access for the top 1%, offering much more affordable minimums, as low as $250,000. Then, around 2020, something  quite unimaginable happened: venture-backed tech companies disrupted the venture capital industry itself. There are now a number of venture software-as-a-service (SaaS) tech platforms which automate the venture back-end. These are now powering a diverse range of new funds and an emerging class of fund managers who can offer participation in venture capital for as little as $5,000 to $25,000, making venture participation affordable to those with just over $1 million in investable assets. This is exactly the level the SEC deems necessary to qualify the investor as an accredited investor, and thus able to assess and take the higher levels of risk. Those who pass this bar with the SEC comprise the top 6% of U.S. investors.

Better diversification

For those who’ve been saving for retirement, their investment options were largely limited to the diversification available through the public markets. Portfolio diversification came from selecting preferences between stocks and bonds, large cap vs. small cap, domestic vs. international and growth vs. value. The primary way to participate in venture capital was through making direct angel investments. Which meant that you might invest in your neice or nephew’s start-up. Those with more time and motivation might join an angel investment group and work with others to collaborate on sourcing, reviewing and selecting ventures to back to obtain more diversification. Now, those with modest portfolios and time availability can access a diversified venture vehicle, if they know where to look.

Engaging Investment Activity

For those who have the time and inclination, investing in private ventures through an angel investment collaborative like Band of Angels or New York Angels is a great approach to take. Not only can such a group provide a robust level of deal diversification, there is a vastly reduced burden in the difficult tasks of deal sourcing, company and founder due diligence and terms negotiation. For those involved, this active approach to venture investing can be both quite interesting and fun, allows investors to meet each other and share in the tasks of vetting a stream of entrepreneurs and businesses. It are somewhat time consuming but they give investors and very good exposure to venture upside, if the group does a good job of making selections. Facebook and Google raised seed capital from angels at the beginning of their journey, before there was much there. The angel investors who invested $5,000 in DoorDash in its seed equity round, would have seen their stock worth about $5 million—a 1000% return—when DoorDash went public in 2020. While the vast majority of business that get started fail, early stage investing, when done well, can generate incomparable returns. Today, established venture funds—which long eschewed seed rounds—are raising seed funds to capture more of the equity growth than they can by investing in later stages.

Investing Your Values

For as long as there have been angel investors, these investors have gravitated towards the kinds of businesses and entrepreneurs that matter to them. Angels have helped support long-shots, mission-driven, and under-represented founders get a start. In an era of climate change, social injustice, disparate access to capital and environmental degradation, large angel communities have organized around investing for “impact.” These groups don’t simply evaluate a venture for it’s potential to grow and earn money, they also evaluate them for their abilty to create a public good or avoid creating harm. Different groups vary in the relative importance they place on “impact” or “return.”  At one end, a fund that limits its investments to ventures working to address a type of problem but expects a market return is considered “catalytic” capital. On the other end, a group that invests primarily for impact and is willing to forego return is considered “concessionary” capital and may in fact raise their fund from philanthropists, who alternatively would simply give away money. An example is Prime Coalition, which deploys concessionary “mission-related” capital and serves the unique purpose of helping social-purpose businesses that may not have the growth prospects to attract venture capital. Then, when there are returns generated, that profit is used to re-invest in other ventures.

Conclusion

Venture capital and angel investing pose the risk that you can lose all of the money you invest but, done well, it also opens up the possibility that you can make millions from even a relatively small allocation of portfolio funds. As such, venture investing is increasingly popular as a way to both diversify one’s investments and improve overall portfolio performance. An expanding universe of venture funds, online platforms and angel investment communities offer many options for investors, who now can select based upon the amount of capital and time they wish to invest. They can also use their capital as a force for good, and invest based upon their own vision of the  future, directing capital to those ventures that address the needs that matter most.