- Venture capital funds give investors access to a diversified portfolio of small- to medium-sized startups that have attractive long-term growth potential
- Venture capital funds are a high risk/high reward proposition
- Traditionally, venture capital investing has been limited to institutional and extremely wealthy investors
What are venture capital funds?
Venture capital funds give investors an ownership stake in a diversified portfolio of small- to medium-sized startups that have attractive long-term growth potential. They are considered a sub-type of private equity.
These funds are managed by investment experts, called general partners, who have an established track-record in identifying and providing funding to the most promising entrepreneurial startups. Often, a venture capital fund will invest in companies within one or more focus sectors, such as fintechs, AI, alternative energy, or consumer tech.
A venture capital fund's lifetime is usually between seven to 10 years, which gives the managers time to identify, invest, and then exit the stake holdings in the fund. Exit strategies include selling the shares back to the company, selling when the company is acquired or exiting when the company lists on a public stock exchange.
The returns provided by companies that do successfully exit can be very, very high. Along with that potential for high rewards, however, comes high risks. Because they are in the riskiest, early stages of their business journey, startups pose a much greater risk of business failure than established public companies. Venture capital fund managers minimize this risk by spreading the fund’s money across a range of companies. That way, if any one of them fails to perform as expected or even fails completely, it will not have an excessive impact on the portfolio.
What are the advantages of investing in venture capital funds?
High Returns – Venture capital funds offer the potential for much better returns than are available in other asset classes. For example, over the past ten years, venture capital generated an average annual return of 16.3% versus the S&P 500 at 14.0%, according to Cambridge Associates. Venture fund managers typically aim to achieve internal rates of returns of 20% to 30% and, if enough companies in the portfolio perform well, these rates of return are achievable.
Investment Expertise – Venture capital is inherently a high-risk, niche field of investing which requires specialist knowledge and experience to navigate successfully. Venture capital funds are managed by fund managers who are experts in this type of investing.
The best fund managers have proven track records in identifying top startups, investing the fund capital in them, and delivering targeted returns to the fund. They may also play an active role in advising the management of the companies that their portfolio, which can increase the chances that those companies will be successful.
It should be noted that while all venture capital fund managers aim to deliver internal rates of return that are higher than the stock markets, many don't. This highlights the importance of choosing the right managers.
Diversification – Venture capital funds not only give investors diversified exposure to multiple startups in the fund, but studies have also shown that venture capital returns have low correlation with returns from public equity markets, providing investors with benefits from portfolio diversification.
What are the disadvantages?
Higher Risks – Investing in startups is inherently high risk. While they offer the potential for exciting growth and high returns, many can (and will) ultimately fail. Investing in a venture capital fund or fund manager that has an extensive track record of success does alleviate the risk somewhat, but these remain high-risk investments.
Lack of Liquidity – Traditionally, venture capital investments have been illiquid, with investors locked in for anywhere from seven to ten years. Investors on ADDX, however, have access to our in-house securities exchange.
High Fees – Fees for venture capital funds are typically higher than those charged for public market equity funds. If the fund performs well, however, investors will still enjoy high returns net of fees.
Barriers to Entry – Only institutional investors and ultra-high-net-worth investors have had access to venture capital funds in the past, given the significant capital investments called for. However, ADDX allows individuals who qualify as accredited investors to invest this asset class.
Who can invest in venture capital funds?
Venture capital funds can cost millions of dollars to buy into, making them inaccessible to all but institutional investors and the extremely wealthy. ADDX, however, democratizes venture capital investing by making it available to investors for as little as S$10,000 to invest in primary offerings and as little as S$100 to trade.
To qualify as an ADDX investor, investors need to meet one or more of the following conditions:
•Yearly income of at least S$300,000 or
•Net financial assets of at least S$1,000,000 or
•Net total assets of at least S$2,000,000
The bottom line
Investing in venture capital funds can be exciting and offers greater potential for gains than virtually any other asset class. However, the risks are also higher. You should choose your funds and fund managers carefully.
ADDX is your entry to private market investing. It is a proprietary platform that lets you invest from USD 10,000 in unicorns, pre-IPO companies, hedge funds, and other opportunities that traditionally require millions or more to enter. ADDX is regulated by the Monetary Authority of Singapore (MAS) and is open to all non-US accredited and institutional investors.