Investing in venture capital: why, what and how?

News: Insight & Opinion | 1 December 2021

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Managing Partner, Claire Madden, looks at the reasons behind strong appetite for VC investments among private investors and the different ways in which they can gain access.

Private capital is hungry for Venture Capital (VC) opportunities right now. According to Atomico's State of European Tech 2021 Report*, 64% of Limited Partners have an increased appetite versus last year for the asset class. The British Venture Capital Association (BVCA) state that, £2.15billion in funding for venture capital investments was raised in 2020 – 20% of which came from private investors**. We are seeing a high level of demand from our clients for these kinds of fund strategies. So, why is this such a popular asset class currently and what are the different options available to private investors looking to gain entry?

Performance is clearly a critical consideration. Across the board, Covid-19 has had very little impact on pricing, and the value of assets has continued to rise. Nowhere is this more evident than in the tech sector which is typically where there is greatest scope for value to be created. Atomico report that European VC is beating US VC (and European PE), and outperforms now across two decades (1,3,5,10,15,20 year horizons).

The pandemic has only brought technology even more to the fore as the sudden shift to remote working and virtual social contact accelerated both innovation in, and adoption of, digital platforms and services. At the same time, the IPO market has heated up, providing an active arena for early-stage investors to exit via the public markets, in a way that hasn’t been seen since the last tech boom.

For those who are comfortable with the risk profile of these kinds of investments, the potential for spicy returns makes them a very interesting proposition, and there’s a strong desire to invest in capital-returning situations. By picking a fund with a top-quality manager in charge, it’s perfectly possible that there will be at least one stellar performer in the pack to drive returns way above what could be achieved by, for example, a private equity buyout fund.

In order to be able to pounce on good opportunities when they see them, many private investors have built up their cash reserves in the past 18 months or so. Indeed 44% of our clients who responded to our survey say they did so last year as a strategy to help them navigate the pandemic. But when they do spot an attractive prospect, investors are now much happier about committing to the long-term strategy required for VC investments. Whereas a few years back, they may have worried that, by tying up capital for five to 10 years, they could miss out on quicker returns from public markets, now they are prepared to be patient.

For some, that might be down to reluctance to increase exposure to the stock market; for others, cash balances have expanded so much that they can comfortably diversify into both simultaneously. With VC and private equity outperforming the FTSE All-Share index over a 10 year horizon with returns of 13.9% per annum versus 5.6%***, it’s an approach that makes sense. According to the Q4 2020 Global Private Capital Review Report from the Burgiss Group, venture funds posted an annual return of 53.9% compared to 21.9% for buyout funds in 2020.

Assessing the options
There are several different options available to private investors wishing to access this asset class:

Angel investing
An ‘angel’ is an individual who invests directly into a company of their choosing, often at start-up or very early stage. They will need to source that opportunity and do all the due diligence themselves, and probably write a sizeable cheque, which could heighten the risk of having a large proportion of wealth tied up in a single asset. Investments may qualify for tax breaks under the Enterprise Investment Scheme (EIS).

Angels will need to be actively involved with the business they are backing, perhaps taking a very hands-on role in terms of oversight and advice, all the way through to identifying an exit. Ensuring they are protected in legal documentation against dilution of their shares, if the company is successful and goes on to raise next-stage funding, is essential. This option is not for the faint-hearted: it is for the experienced only.

Crowdfunding enables individuals to invest passively (i.e. no hands-on approach required in managing the investment) in single assets of their choosing over a digital platform. They can invest in small amounts and there is a wide choice of platforms and investee companies available, making it easy to do at low levels of exposure. Investments may qualify for EIS relief.

However, since platforms are designed to raise money for companies who pay their fee, there’s potential for a conflict between the way they serve business’ and investors’ interests. It can also be very difficult for investors to do their own due diligence on the companies themselves and they are reliant on the information provided by the platform.

VCT (‘Venture Capital Trusts’)/EIS portfolio services
These are another route to passive investing, but instead of self-selecting specific, single investments, individuals invest in a portfolio of assets chosen and managed by an experienced venture manager. They are structured to hold assets over the longer term, and VCTs in particular can be quite good vehicles for dividends. Tax breaks are available on entry and exit. Investors can buy shares in the VCT or invest a sum of capital to be deployed by an EIS portfolio manager.

However, those that invest using EIS portfolio services have no control over when funds are invested or when exits will happen (and therefore, when they will get those tax breaks). When it comes to VCTs, because tax breaks do not apply to shares bought on the secondary market, liquidity tends to be limited.

Quoted investment trusts holding venture assets
These are publicly quoted vehicles which allow individuals to buy shares in a portfolio of VC investments made by a fund manager, similar to a VCT – although there are no tax breaks. Since they are quoted and therefore, have to adhere to disclosure requirements, they are relatively transparent, and their shares can be bought and sold via a trading platform.

On the downside, there is currently not a huge amount of choice available on the market: not many venture managers have opted to raise capital this way. Plus, they generally trade a discount to net asset value which means that returns are subject to what is happening in the market rather than aligning with the performance of the portfolio’s own individual assets.

Private VC funds
This is another way for investors to gain exposure to a portfolio of investments selected and managed by an experienced venture fund manager – but these are generally reserved for institutional investors. Large investment minimums are the norm and cash can be tied up for long periods.  However, the top venture managers with the strongest deal flow tend to raise and deploy capital through these vehicles.

Private investors rarely gain access to these sorts of funds, which is why we developed our model so that we can pool our clients’ capital and enable it to act as an institutional investor, securing allocations to top performing funds and undertaking all the due diligence on their behalf. The attractiveness of this option has been more clearly demonstrated than ever recently, as our clients have invested £19m in the last six months alone, across three venture funds and one co-investment deal. This option is not open to retail investors, however: only those who can demonstrate the appropriate experience and understanding of the risks and illiquidity involved.

A confluence of factors is making VC appealing at the moment, and given that there are several access routes open to private investors, there’s no reason to suppose interest will wane any time soon. Individuals will want to weigh up the pros and cons of each option carefully, to select the one that’s right for them. For those with the risk appetite, there’s a lot to chew over.