The Perceived Risk of VC
What's riskier: working for a high growth startup or investing in investors?
I recently joined a panel about "the future of jobs in the digital era" with an HR brand ambassador of a tech company that received +100m in VC investments. She was smart, super motivated and a very impressive person in general who considers herself a digital nomad.
When I explained to her after the panel what I do, she said that it seems to be a great responsibility to take the money of investors and invest it in startups. "What about the risk? What if you can’t pay back the money?"
It really surprised me that someone working for a high-growth startup, which received lots of Venture Capital money, considers investing in VCs risky business. Even when I explained that my fund has 300 selected companies in various geographies, verticals and vintages, she didn’t seem convinced.
If a digital nomad believes that her contract with a single high growth startup is less risky than investing in venture capital, how do we make family offices and pension funds understand it?
Responsibility for Risk
Risk, to some extent, is relative. On a day-to-day basis, most people’s decisions - work or personal - don’t involve much risk-taking. But when investing large sums of their own money, people often take their time to research and compare their options.
And so when it comes to making big decisions with money as a job, many people may see that as a daunting task. Employees and contractors don’t carry the same amount of responsibility in a company as higher decision makers. Their daily decision-making doesn’t usually involve millions of dollars.
But, just like anyone making a financial decision, I do my research. Much like a graphic designer spends their time learning a new tool or following trends, I spend my days speaking with experts and reading about emerging industries.
At the end of the day, this ensures my limited partners (LPs) that I’m well-informed so that they feel comfortable allowing Multiple Capital to invest their funds.
Due Diligence: Do Your Own Research
Extensive due diligence is one of the best ways to mitigate risk. When researching a possible fund, fund of funds (FoF) managers may look at:
Track record
Industry and market
Portfolio companies
Press
These are just a few of the metrics that help limited partners (LPs) understand the potential risks of investing in a particular manager or firm.
It’s similar to the way investors evaluate startup pitch decks. The founder shares the highlights and vision of their company, and then the potential investor asks their questions, following with their own research afterwards.
This hands-on approach to due diligence can reduce the knowledge gap and provide greater insight into the fund manager’s strategy and mindset. And that understanding can nearly eliminate any fear of risk.
Are Emerging Fund Managers Extra Risky?
The evaluation criteria and process is slightly different when it comes to investing in emerging fund managers. Their track record and portfolio companies can’t be significant factors because they’re relatively new to the ecosystem.
At Multiple Capital, we have found that smaller, newer funds tend to outperform larger established funds. In fact, Cambridge Associates reported that new and developing funds consistently ranked among the top 10 performing funds over the past decade.
Pictured below: New and developing funds consistently rank among the Top 10 Performers, with new funds outperforming all other categories for the showcased US VC Ranking (as of June 2019)
So while some traditional metrics may be missing from an emerging fund manager’s CV, we know that they are statistically more likely to perform better than an established fund. In other words, newer funds aren’t nearly as risky as many people think.
In these cases, due diligence requires numerous conversations with the emerging fund managers, in addition to deeper research into their investment theses components (ex: industry, geography, market, stage). While a fund manager may not have an extensive track record, they may be extremely knowledgeable or experienced in their market, which can be just as valuable.
To some extent, this job may require the LP to be a subject matter expert themselves. But at the end of the day, the LP has to trust that a particular emerging fund manager will make well-educated investment decisions.
Final Thoughts
Investing in a particular type of fund manager is just one aspect of Multiple Capital’s overall strategy. Diversification of geography, industry, business model, and target market are just a few of the numerous ways we reduce risk across investments.
There is no way to guarantee anything in life, and certainly not when it comes to venture capital. Understanding how to mitigate risk is a crucial component of our job in order to create a sound strategy our LPs can trust.
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