Capturing Value Earlier — Why VC Persists as an Asset Class
I’m often asked why venture capital is an attractive asset class. I usually provide a high-level response such as “VC is an effective portfolio diversifier” or “VC has the potential to deliver outsized returns,” or something of the sort. While there’s nothing wrong with these statements, they only answer the question of the “what” but not the “how” or “why” VC is an attractive asset class.
Over the years, I’ve had many conversations about this topic. One of the most interesting conversations I had was with Derek Batts at Union Heritage in Detroit, Michigan. Derek is an industry veteran with a strong background in public and private investments. Derek spent the first 20+ years in public equities and years later added venture capital to his investment strategy. I asked Derek why he made the decision to add VC and he said that over the years he observed that the average age of publicly traded companies was declining over time. As such, it made logical sense that to participate in the upside of high-performing companies he needed to invest in them earlier. So for the next ten years starting in ~2011, he made angel investments to prove his investment strategy prior to starting the two VC funds he currently manages at Union Heritage.
The market evidence supports Derek’s reasoning. According to a 2023 report from McKinsey, “the average life span of a company listed on the S&P 500 was 61 years in 1958. In 2023, it was less than 18 years. Technology is the driver of this change. In 1980, technology stocks accounted for 6 percent of the S&P 500; today it is close to 30 percent. ” (1). According to Ernst & Young, the average lifespan of a publicly traded company in 1958 was 67 years. In 2023, it was 15 years (2). While there is a slight difference in the company age between McKinsey’s and Ernst & Young’s analysis, the overall message is the same: The likelihood of overlooking the value creation phase of high-growth companies has increased significantly, as these companies now expand at a much faster pace than in previous decades.
Like most data sets, the “average” is skewed by a small or large number. In the case of the S&P 500, the oldest company is Bank of New York Mellon which was founded in 1784. The newest is TKO Group Holdings (TKO) founded in 2023. As a sidebar, TKO is a merger of two older established organizations. While it is technically a “new” entity by public-listing standards, I would argue it is not a brand-new company. But I digress.
According to a 2024 article in Barrons (3), the tech sector accounted for 30% of the S&P 500 benchmark index value. A large portion of the value creation can be attributed to the Magnificent Seven (“Mag 7” for short) which includes Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla. The commonality between these companies is that they are all venture-backed businesses. What then does that tell you? Would it have been better to invest in these companies when they were smaller? Maybe. Maybe not. The counterargument is that it would have been difficult to know which of these companies would grow to be as big and successful as they are today than when they got started. Furthermore, not everyone had the opportunity to invest in these companies because they were only available to a select few individuals, venture capital firms, and institutions.
To further compound the access problem, most high-growth technology companies stay private for longer. According to Pitchbook Q4 2024 Venture Monitor, “~45% of tech unicorns (i.e., companies valued at or greater than $1B) were nine years old or older and their median time since their first VC round was 8.5 years.”(4) Enabling this new paradigm are late-stage, growth-equity investors and sovereign wealth funds with ample cash reserves to bolster these companies while they grow in their later years.
So, how should (accredited) investors think about accessing companies earlier? First, it’s important to understand that the majority of venture-backed companies either merge with or are acquired by larger companies and never go public. Just because you didn’t invest in, say Apple, before it became public doesn’t mean you’re missing out on what the venture capital industry has to offer. Many venture capital funds across the country have access to high-growth companies that most people will never know or hear about. Second, it’s also important to remember that venture capital may not be for everyone. If targeting companies earlier in their life cycle isn’t your preference, there’s nothing wrong with that. However, for professional investors like myself, investing early makes the most sense since our goal is to participate in as much of the value creation as possible before a company has a major liquidity event (e.g., merger, acquisition, or going public). In other words, investing early creates the opportunity to capture significant growth potential before a company reaches its peak valuation. While it carries higher risks, the rewards can be substantial for those willing to commit time and resources.
Cheers — KM
Sources:
(2) EY
(3) Barrons
(4) Pitchbook
Disclaimer: The information provided is for informational purposes only and does not constitute an offer, solicitation, or recommendation to buy or sell any security, investment product, or financial instrument. I am not endorsing or recommending the purchase or sale of any particular stock or investment. All investment decisions should be made based on your own analysis and in consultation with a qualified financial advisor.
