The opportunity in early stage venture capital

In our experience 20% of companies drive 80% of returns, so success hinges on accessing the best opportunities. However, rather than being stacked against you, a well thought-through approach to portfolio construction, in our view, can ensure the odds are stacked in your favour.

Venture capital has financed some of the biggest successes in technology of our time

Venture capital has a rich history of delivering both strong returns for investors and helping early stage companies realise their potential.

Previous venture capital (or VC) success stories include the first US public company to be worth more than $1 trillion, Apple, and other household names such as Microsoft, Amazon, Facebook and Google, each worth more than $500 billion. VC has turned entire industries on their heads. The music, newspaper, and media industries have all been disrupted in this way. Furthermore, venture capital-backed healthcare companies have developed medicines that are used to defeat previously incurable diseases, while others search for a cure for cancer. It would not be an overstatement to say that venture capital has been behind many life changing developments.

From an investor’s perspective, venture capital provides access to the growth stories of tomorrow1 and has a track record of delivering very strong long term returns. The Cambridge Associates US Venture Capital Index has returned 19% a year over the 30 years to 2017, net of all fees and expenses2 .

It is also a significant part of the investment landscape—the venture capital/growth sector makes up around a third of annual private equity fundraising volumes.

However, it has also been described as a game of “high risk poker”.3 Venture capital, if done incorrectly, can be a way to lose a significant amount of money and in the past, some investors have burned their fingers.

Memories of crashing technology stocks during the Dotcom bust also haunt some investors. Invest with bad funds and you can lose most or all of your capital! However, it is important to note that losing money often results not from venture capital investing itself, but from relatively amateur mistakes that we think skilled investors can easily avoid.

This paper is split into two parts. The first sets out some counterintuitive truths about venture capital investing. Many common objections are misplaced. The second details five secrets to successful venture capital investing.

1In contrast, public markets are increasingly capturing a larger, more mature snapshot of the corporate sector as companies elect to stay private for longer. For more information, see What is the point of the equity market? Schroders, April 2018

2 The Cambridge Associates LLC US Venture Capital Index® is based on data compiled from 1,794 US venture capital funds (1,150 early stage, 210 late & expansion stage, and 434 multi-stage funds), including fully liquidated partnerships, formed between 1981 and 2017. The return quoted is a pooled horizon internal rate of return (IRR), net of fees, expenses, and carried interest.

3Michael Moritz, Sequoia Capital, articles/2015-10-17/sequoia-s-michael-moritz-q-a-venture-capital-is-high-risk-poker