Investor Education Series: How Venture Capital Compares to other Asset Classes
Overview
In the month of February we will be sharing a series of educational posts for non-institutional investors. We get a lot of questions about private markets for those new to the asset class, so the goal is to make it easier to understand and more accessible to the average person.
In last week’s post we discussed “What is Portfolio Construction and Why Does it Matter to Venture Capitalists?”
In this week’s post we discuss how venture capital compares to other asset classes.
Intro
I was in a meeting this week with an investor who had no experience with or exposure to the venture capital asset class. I sometimes find this surprising for a couple of reasons: First, a large majority of the world’s largest and most influential tech companies are VC-backed; and second, the VC industry has been around for more than 79 years already.
Quick history lesson — The venture capital industry started in 1946, a date most people refer to as the start date of the first (formal) venture capital fund in the United States by a firm called the American Research and Development Corporation (ARDC). ARDC was a public company that invested in private companies. Its largest exit was a $77K investment that increased in value to $355 million over a 14-year period. That’s an 84% internal rate of return (IRR) and a 5000X multiple on invested capital (MOIC). With this type of success, the VC industry was sure to draw the attention of others, and as a result the industry grew substantially over the subsequent decades (source).
Stage of Investment
An important distinction between venture capital and other types of financing is the stage in a company’s life at which VCs invest. The average individual investor most often invests in established, publicly traded companies. Whereas, most VCs invest at the beginning, earlier stages of a company’s life. Companies at the early stage need capital and time to grow, so it’s often better for them to partner with investors who can provide financial support but also offer strategic advice along the way.
Risk vs. Reward
Performance/Return expectations for venture capital are most always higher than for other asset classes because of the higher risk involved. Illiquidity, timing, and industry risk discourage many investors from investing in venture capital. These are valid risks that must be disclosed. In addition, not all investors can invest in VC unless they meet certain income or net worth requirements, as defined by the securities and exchange commission guidelines (Link).
See the chart below from Angel List comparing VC to Stocks and Real Estate (source).
Conclusion
If you’re curious about VC and want to learn more about the industry, I’ve listed below a few of my all-time favorites. If others have resources to share, please include them in the comments.
- The Power Law, Venture Capital and the Making of the New Future by Sebastian Mallaby
- The Code, Silicon Valley and the Making of America by Margaret O’Hara
- The Money of Invention by Paul Gompers
- Mastering the VC Game by Jeffrey Bussgang
- The Secrets of Sandhill Road by Scott Kupor
In next week’s final post, we’ll discuss how VCs return capital to investors.
Cheers — KM
