The Risks of Venture Capital Investing

Venture Capital Risk

The first thing people seem to think of when they look at alternative investments is the “Risks of Venture Capital”. This is understandable; most companies at this stage of development do not survive. It’s not uncommon for investors to lose all of their principal.

First and foremost investors in venture capital need to be accredited investors who are prepared to lose their entire investment and must plan on not seeing any return on their investment for many years, if at all. Anyone who understands those risks and is still considering an investment in venture capital must deploy sound investing fundamentals that include diversification and comprehensive due diligence.

What does it mean for a security to be illiquid?

When a company’s securities are “illiquid,” it means that investors cannot sell the securities they own in that company to get their cash out of the investment (even at a loss) whenever they want to. They have to wait for either a “liquidity event,” like a company sale or IPO, or find a willing buyer independently. This makes the investment riskier than typical investments in publicly salable securities such as stocks sold on the NYSE or NASDAQ markets, registered mutual funds, or similar investments where there is a ready market for the securities.

A company may be illiquid because:

The sale of its shares is not allowed under applicable securities laws
There is no active market where its shares are bought and sold on a regular basis

Whatever the reason, buying and selling shares in an illiquid company is more difficult than what most investors are accustomed to.

Liquidity is significant concern for startup investors since venture capital investments can take several years to yield a return and investors are usually unable to sell their securities in these companies prior to their liquidity events. This means that investors in illiquid securities must have sufficient other assets that are liquid to meet their financial needs.
If you are considering an investment in iSelect Fund, you should work with your financial advisor to determine an appropriate allocation of illiquid securities based on your unique financial needs and portfolio of investments.

What is an Accredited investor?

Investing in many private offerings is limited to “accredited investors”. People are often confused about the meaning of this term, so I’d like to take this opportunity to define the meaning that most frequently applies.

An accredited investor, in the context of a natural person, includes anyone who:

earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR
has a net worth over $1 million, alone or with a spouse (excluding the value of the person’s primary residence).

On the income test, the person must satisfy the thresholds for the three years consistently either alone or with a spouse, and cannot, for example, satisfy one year based on individual income and the next two years based on joint income with a spouse.

Why is this important? Well, the accreditation threshold exists to protect investors. In our industry, investors should be able to absorb any potential losses and tolerate the relative illiquidity of the venture capital asset class.

Why is due diligence essential to investing in private securities?

Due diligence is a rigorous process to evaluate the risks and opportunities associated with a company’s business plan, verify the statements made by the company as to its business prospects and core technologies, and test management’s mettle by asking detailed questions regarding their business and their ability to respond to adversity.

This is a critical but time-consuming part of the venture investing process. According to the Ewing Marion Kauffman Foundation, investors who spend more than the median of 20 hours on due diligence perform better than those who spend less than 20 hours, and those that spend more than 40 hours outperform their peers by a large margin.

Why is diversification necessary to manage risks?

If you invest in one or only a few venture capital stage companies, you will almost certainly lose your entire investment. Putting all your eggs in one basket is almost always a bad strategy. In the venture capital world, investing in one or only a few companies is the surest way to lose all of your money quickly. Venture capital funds manage this risk and frequently enjoy significant profits by spreading their investment dollars around, taking many bets on many opportunities.

Consideration

With 2021 well underway and with public markets still strong, we think it is an important time to highlight some of the key private market, venture investment themes that iSelect fund has identified for the year. We believe technologies transforming the Agriculture, Food and Wellness markets will flourish, with a focus on four areas: technologies that enable better food choices to drive better health outcomes, technologies that drive better, more profitable farm operations, technologies that drive the Consumerization of Healthcare, and biome-based treatment technologies. At iSelect, we invest for impact AND performance. We offer qualified investors access to emerging growth companies through our national venture capital strategy. Our unique structure allows our investors to continue to invest in these companies as they develop.

Timing

Why is now the right time for venture? The answer is that now is not explicitly the right time. Venture is something we need in our economy at all times. Now is not better than any other particular time. The question is, why ever stop? When we look at the challenges we’re facing in food and healthcare the reality is there is someone, somewhere who has an insight about how to build a product that will solve those problems. And if they put the right resources to it, they will succeed. As long as we need new technology to make life better or make our lives more enjoyable, we need venture capital to help fuel those entrepreneurs.

What is iSelect as a product?

iSelect is a very unique product, but when you break it into its parts it’s fairly easy to understand. On the front end we’re a traditional venture capital fund. We have a diligence process. We have an investment process. We have categories of industries where we have focus and real expertise, and we invest in companies in those areas that meet requirements for the fund. On the back end we’re unique in that we don’t raise a large amount of capital at one time and deploy it over the life of our fund. Each deal that we bring onto the fund, our investors have to prove and determine to invest in that deal. We have to constantly prove our diligence standards. It’s accessible, transparent and easy for investors to come in and see our comprehensive process.

What is the ideal iSelect company?

We are looking for founders that are passionate and we want the problem they’re trying to solve to be big, real, and painful. We want the solution to be revolutionary and we want our capital to be able to help them solve that problem. We want to know that they have customers involved and that the solution they’ve come up with actually meets those customers’ and market needs. And we want the team to be capital efficient with the money they’re spending.

What does the ideal iSelect company look like?

We’re looking for a company that has an opportunity to have a 10x return to our investment or greater in a period of three to seven years. What excites us at iSelect are companies that are solving big problems. We want companies that are going to be the Monsantos of the future. Not just in the size and the scope, but the impact they have on people’s lives. We want to create positive impacts on people’s lives, so we invest in areas like agricultural production and areas like producing healthy foods for our kids. They are problems that impact real people’s lives on a daily basis. That’s what we’re trying to do at iSelect. We’re trying to solve the big problems out there. Find ways to bring capital to the entrepreneurs who are the real heroes out there getting up every morning, beating away at these things that are problems that you and me and everyone else faces in their everyday lives.

What is iSelect?

iSelect is a venture capital firm. What that means is we look at hundreds and hundreds of different companies and we apply tough diligence standards to each of them, looking at whether the team has a good plan for growing the business, whether the team is qualified and credible, and more. We do that to resolve the few who provide the best opportunities for investors. And then iSelect takes that smaller set of investments and goes to investors who are interested in venture capital and provides a way for them to invest in these companies, either individually or all at once. We co-invest alongside other venture capitalists. We source transactions through to an exit where the company would become public or get bought. And we manage that whole investment process on behalf of our investors.