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Diversify Differently: What the Heck Does THAT Mean??

VCapital Team, July 17, 2020

Investors most certainly turn to venture capital for investment home runs. We urge our VCapital investors to diversify their entire portfolio both with -- and within -- the venture capital asset class.

Diversify An Entire Investment Portfolio
Most individual investors’ assets are concentrated primarily in traditional asset classes, such as stocks, bonds, their homes, and their businesses. Within a total financial mix, venture capital can represent smart diversification as an alternative asset class that tends not to correlate with the ups-and-downs of the more traditional asset classes. 

One reason why venture capital tends not to correlate with stocks and bonds is because venture capital is inherently long-term in nature. Venture capital is:

  • the polar opposite of day-trading
  • not liquid like publicly treaded stocks and bonds

When major economic uncertainty emerges, such as at the start of the COVID crisis, investors may liquidate stocks and bonds in declining markets, taking losses to amass cash or maybe even out of necessity to meet a margin call. Venture capital exits, on the other hand, are managed to align with opportunity for attractive returns. 

Also, since venture capital investment is concentrated in innovation, it is inherently diversifying in nature relative to traditional stock market investing. The public stock market largely represents today’s economy. While P/E multiples may be greater for industries and companies with greater growth potential, those industries and companies are still predominantly well established. Alphabet, Amazon, Facebook, and Netflix may have lots of room to grow further, but the venture capital market, and especially VCapital’s early stage focus, offers investor access to tomorrow’s advances and new industries. 

Frankly, the public stock market has spoiled investors over the past decade. Notwithstanding the frightening market plunge in March, which technically ended the longest bull market in history, the persistence of that galloping bull before COVID and again since March has lulled many investors into a complacent belief in never-ending stock gains. 

History suggests otherwise. Just three years ago, in 2017, when our CEO, Len Batterson, and VCapital Advisory Board Director Ken Freeman co-authored Building Wealth through Venture Capital, they pointed out that despite all the stock market enthusiasm at the time, the S&P 500 had delivered returns over the previous 17 years (Jan. 1, 2000 through Jan. 1, 2017) averaging slightly below just 5%/year. That included dividends. They also cited Warren Buffett’s recognition in the 1980’s that the Dow Jones Industrial Average at year-end 1981 was exactly what it had been at the end of 1964 . . . no net gain in 17 years. 

The bond market similarly has spoiled investors over the past decade. With the Fed driving down interest rates since 2008, bond prices have surged over the decade. But with interest rates so low now, opportunity for further appreciation is negligible. 

Diversify WITHIN the Venture Capital Asset Class
We know venture capital is a home run business. Only 15-20% of all venture capital investments typically earn a positive return. Perhaps half of those generate excellent, home-run-type returns.

VCapital’s objective on every investment is to hit a home run. We are very selective, performing extensive due diligence on every investment. We only invest in ventures that we believe have home run potential. But we’re seasoned professionals and realists. We know they won’t all turn out to be home runs. 

We have just begun raising funds for the tenth company in the VCapital portfolio, EDJX, which aims to pioneer the Internet’s next generation, called Edge computing. And we continue our search for those highest potential ventures, which are then screened down further through exhaustive due diligence, to diversify our portfolio further. This increases the likelihood of hitting at least one (hopefully lots more than one) home run. It simultaneously reduces risk of loss. 

Three Ways to Invest with VCapital
We recommend strongly that our investors similarly diversify their investments in the venture capital asset class. VCapital investors can do this in three different ways:

  1. Invest in a large enough number of our portfolio companies for meaningful diversification. We’d recommend investing in at least five or six of your favorites. You thereby acquire a share of each of those companies and the opportunity to enjoy a proportionate share of the ultimate returns from each.

  2. Invest in VCapital Management Company. That way you acquire a share of the firm’s 20% carried interest in the returns enjoyed across all of our portfolio companies. That is how we are compensated. You effectively become our partners. 

    We believe that sharing in VCapital Management Company’s 20% carried interest represents exciting return potential. Several of our portfolio companies that are closed to further investment right now are doing very well, continuing on courses that could result in those home run returns. In some cases – e.g. Intensity Therapeutics, Atlas Space Operations, and Raydiant Oximetry – the early valuations when our investments were made are far below valuations expected in any subsequent fundraising rounds, so you can benefit from all the rigorous screening and due diligence that led us to get in early.

  3. Invest in one or more of your favorite VCapital portfolio companies + VCapital Management Company.  You can thereby enjoy your proportionate share of the returns achieved by the companies you invest in individually as well as a share of VCapital Management Company’s 20% carried interest on the returns earned by all the companies in our portfolio. 

Any of these approaches will help manage risk while increasing the likelihood of enjoying the exceptionally attractive returns that characterize venture capital.  

Talk to us.
We are available by phone or email to continue this conversation. We look forward to discussing how venture capital can fit into your wealth management strategy.