Venture capitalists seek out businesses with the most innovative ideas and the highest growth potential. For much of the 20th century, however, this area of investment was offered exclusively to ultra-high-net-worth individuals and their families. Fortunately, with recent policy movements in the venture capital space, such as the JOBS Act, some funds now offer this area of investment to individuals for a relatively low buy-in. With Crowdfunding turning everyone into VCs, what should investors look for in a venture capital fund?
1. Diversification
Before we dig deeper into what, first let's understand why venture capital? Aside from high reward potential, one of the main reasons investors flock to venture capital is diversification. This strategy mimics the risk mitigation of portfolio diversification. While many individual investors spread their portfolios into stocks, bonds, and money markets, it is wise to take the long term approach and invest in venture capital as an asset class. However, it's important part is to seek out managers with the ability to outperform consistently by adding meaningful alpha. Please read Ms. Desai's blog, "Invest like a Pro with Crowdfunding," to learn more.
2. Management
While the general partners of a VC fund are responsible for vetting and executing investments that will earn a successful exit for all investors in the fund – it’s mainly a people business. It’s important to pick a manager you trust and share mutual respect for. Other key factors to consider when evaluating a management team include the managers’ education, industry experience, network, and vision. Please read Ms. Desai's blog, "Founders: How to pick your VC?," to learn more.
3. Strategy
Regardless of their discipline, every investor has his or her own investment strategy, and so does every venture capital fund. A venture fund’s strategy dictates the type of investment it looks to make, be it in a cash-flow-positive business, a rapidly-expanding business, a path-breaking sectors, or one that exhibits some of all. Sector, Stage, and Size also play an important role. Most venture capital funds are industry specific, such as healthcare, manufacturing, or technology. However, each industry performs well at different times. Currently, majority of the investments are made in the AI sector, which requires larger check sizes, which is concentrating the venture business. According to Pitchbook in 2024, 30 firms raised 75% of all capital raised by VC funds in the US, mostly investing in AI. But, what about the other industries? Do they not have any potential?
Companies require financing at several different stages, including seed, early stage, growth, expansion, and later stage. While returns can be realized by investing in the right company at any stage, early and growth stage investments generally perform better. The size of the fund also plays an important role here. Not necessarily the case always, but smaller funds sometimes target higher-multiple, riskier early-stage investments, while larger funds may focus on steadier, later-stage deals. Ensure the fund size is appropriate for its stated strategy and the target market's capital requirements.
4. Financial & Legal
The last but important aspect to look at is the numbers. How much is the management fee? What is the carry? Does the GP have skin in the game? Past IRR numbers, if available? Review the fund's legal documentation, such as the Private Placement Memorandum (PPM) and Limited Partnership Agreement (LPA), paying close attention to governance rights, liquidation preferences, and anti-dilution provisions. How does redemption and liquidity look? And finally, how do taxes work?
Note: This is not financial guidance. While it is important to have a diversified portfolio, please consider if you are looking for income, capital preservation or growth? Along the way, how tolerant are you of volatility or risk-averse? And is liquidity a concern? The answers to those questions inform allocation decisions, within both traditional and alternative assets. Please note we may offer investment products that invest in the asset class(es) or industries included in this blog.
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