TLDR: Investing in VC isn’t as scary or inaccessible as people think.
Investing in VC is opaque. For those starting out, there are some things to consider... but also…this isn’t financial advice…so below are simply my own views on allocating to venture, not to be taken for anything other than personal opinion.
A lot of people I’ve spoken to like the idea of making big upside investments, but it can be a bit intimidating too. I was just sharing my personal approach recently in a VC Academy course I was teaching, so I thought I would type up some of the broad thoughts here as well.
1) Decide what % of your net worth makes sense to allocate to an illiquid asset class.
I personally target 10%, so that I’m not risking a detrimental amount of money, but in the event I'm able to 10X the capital, my net worth would double, making the risk worth the upside for me. Of course, getting to 10X is a major outlier, the more likely outcome is 1-3X over 7-10 years, but there are also the rare and storied funds who have achieved 50-100X as well like Benchmark I (92X). I have target allocations to other asset classes and emerging technologies as well—like blockchain and longevity.
2) Single company investing is risky.
If you are going to do direct investing, divide your total allocation from #1 above by 10 or 20 minimum so that you can do enough deals to diversify the risk and increase the odds of an outlier. Early stage venture follows a Power Law distribution where one winner should in theory pay for all of your losses and much more. I personally targeted 20 deals over 2 years when I started, but ultimately made 36 investments over 6 years. My check sizes were minimal, and mostly on AngelList. You can get started on platforms like this for as little as $1K/deal, as long as you’re accredited.
3) Consider investing into one or multiple funds instead of directly into companies.
There are management fees (2% per year) and carried interest (20%) you will pay in the event of profits, but a fund will give you greater diversification and deeper diligence. You can usually co-invest additional capital directly into companies in their portfolio as well. Tactically speaking, decide what portion of your venture exposure you want to be in managed funds, and spread that out over multiple funds and vintages. Access to these funds may depend on relationships and/or minimum check sizes. Emerging managers will usually accept smaller investments, as low as 25k-50k, where institutional VC’s may require $1m or more to take part. You’ll want to make sure the investor has unique deal flow, a refined thesis, and a personal track record. Talk to their founders too.
4) Most people think investing into a fund is a huge commitment. It’s not as scary as you think.
Capital is usually called a couple times a year for 2-5 years, so if you were to commit $100K, you might only be wiring $12.5K twice a year for 4 years. Not dissimilar to the max contribution to your 401k ($22.5K vs. $25K per year). The difference is your employer isn't matching your VC investments, the 401k is more liquid despite tax penalties for taking it out early, the VC fund has the potential to have non-linear upside where the 401k will not, and if investing early stage then they both have major tax advantages. I personally prioritize the 401k, especially when there is employer matching, before allocating to VC. But it’s also important to note that if you are investing into a fund writing valuations of $50m or less, then the capital gains will have tax advantages as well through Qualified Small Business Stock (QSBS), which allows for $10m of tax-free gains on each individual investment.
5) You're unlikely to create generational wealth.
Be realistic about the risk and the opportunity cost of being illiquid. If it sounds too good to be true, it probably is. Find Partners who will be honest with you about expected returns. For pre-seed & seed funds with low valuation targets, 3-5X with a 30% IRR is top quartile. Early-stage VC has historically returned about 19.7% IRR’s on average (Fig. 5). Keep in mind this data is 1981-2015, and we’re currently in a correction. That said, early stage entry valuations have held pretty constant (Carta).
6) It takes time.
Most funds have a 10-year life, and early-stage funds can take 7+ years before they even begin returning capital. You shouldn’t commit your full target allocation in a single year or check. Instead, pick a fund or two, go in with the smallest check they'll allow, get access to the quarterly updates, get to know the partners, their founders, and help the companies. If you picked a great fund, you’ll be able to co-invest in great companies and their brand will compound, so you'll want to have capital reserved to be in Fund II, III, etc.
This one may need a Part II. What didn’t I answer or cover?
See you Monday.