In focus

Thought Leadership

The five secrets of successful venture capital investing

Steven Yang

Steven Yang

Head of Global Venture Investments

Michael McLean

Michael McLean

Investment Director

Duncan Lamont, CFA

Duncan Lamont, CFA

Head of Research and Analytics

To those less familiar with it, venture capital can appear to have almost mystical qualities. The ability to invest in companies like Apple, Microsoft, Amazon, Facebook and Google in their early days. To back them and help them grow. To disrupt entire industries. To invest in life-changing medical advances which render previous incurable diseases curable. All the while earning substantial investment returns – the Cambridge Associates US Venture Capital Index has returned 19% a year over the 30 years to 2017, net of all fees and expenses1.

Some may think that that this sounds too good to be true and that these opportunities must be restricted to only an elite few. They are wrong. It is true that 20% of venture capital companies generate 80% of the returns and top quartile funds outperform bottom quartile funds by almost 15% a year, on average2.

The best companies prefer to partner with highly regarded venture capitalists, and for good reason. The effort involved in taking an early stage company and helping it grow should not be underestimated. The best general partners add the most value and therefore tend to attract the best entrepreneurs. Access to the best funds, and companies, is essential for success in venture capital.

Read more: The opportunity in early stage venture capital

However, that does not mean that these opportunities are unobtainable. Even novice investors can get access to top funds, so long as they invest through the right partner. By piggy-backing on a more experienced investor’s credentials, through a co-investment or fund of funds investment, it is possible to get a seat at the top table.

Venture capital is also not as risky as some investors fear. While a notable percentage of venture capital-backed companies fail to survive, others deliver returns of several hundred or even thousand percent. The individual nature of each investment can drive significant diversification benefits at the portfolio level. Analysis we carried out of realised entry and exit valuations demonstrates that this is a fundamental characteristics of venture capital investing, not simply a consequence of valuation methodology, as might be challenged. One consequence is that, although individual venture capital investments are higher risk than public equity markets, venture capital portfolios are not.

Venture capital investing is full of counterintuitive truths, such as those outlined above. In our paper on The opportunity in early stage venture capital, we cover these in more detail, and others, as well as setting out the five secrets to successful venture capital investing. The opportunity to invest in game-changing companies with the potential to disrupt entire industries is there for the taking, but only if done correctly.

[1] The Cambridge Associates LLC US Venture Capital Index® is based on data compiled from 1,794 US venture capital funds (1,150 early stage, 210 late & expansion stage, and 434 multi-stage funds), including fully liquidated partnerships, formed between 1981 and 2017. The return quoted is a pooled horizon internal rate of return (IRR), net of fees, expenses, and carried interest.

[2] Over the 2003-13 vintage years (more recent years excluded as it typically takes five years for a venture capital portfolio to develop), top quartile venture capital funds outperformed bottom quartile funds by 14.5% a year, on average. Source: Cambridge Associates, Schroder Adveq.

Read the full report

The opportunity in early stage venture capital 8 pages | 510 kb