October 5, 2020
Is Investing in a Venture Capital Fund Worth the Risk? H Venture Partners
There are tons of tried-and-true ways to build wealth. You can open up an IRA, put money in a 401K, set up a high-yield savings account or invest in the S&P 500. But what if you had the chance to invest in companies that will literally shape our future—from the next big food trend, to a whole new way to work out—and build wealth at the same time? At H Venture Partners, we invest in the iconic consumer brands of tomorrow. And it’s a good time for it.
As Black Swan events like COVID-19 disrupt industries, various sectors shrink and expand, and the market becomes volatile. When this happens, it’s more important than ever for savvy investors to consider venture capital as a strategy to diversify their portfolios and increase their chances of positive returns. With disruption comes opportunity—and that’s exactly what venture capital looks to maximize.
We know what you’re thinking: Venture capital is risky, though, isn’t it? The answer is yes. But also, maybe less than you think.
The Upside: Venture Capital is the Highest-Returning Asset Class
Investing in venture capital can help diversify your portfolio, especially while the market is volatile. While venture capital is loosely correlated with the market, it has also outperformed the S&P 500 by two times over the past 30 years. This is why institutions like Yale and Dartmouth allocate a significant portion of their endowment—38% and 25% respectively—to venture capital*. Strategically investing in venture capital, through an experienced fund manager, can potentially strengthen your investment outcomes.
Venture capital is also one of the most tax efficient asset classes, with most early stage investments qualifying for a 0% capital gains tax (Section 1202 QSBS), meaning you might not have to pay taxes on potential returns. On an after-tax basis, this means a 15-20% bonus. So, then, why aren’t more Main Street investors buying in? It’s not accessible. The minimum investment for most venture funds is $1MM, meaning the average person can’t get involved.
H Venture Partners Brand Fund takes a different approach. Instead of a $1MM minimum, the Brand Fund has a $50,000 minimum investment for investors who want to dabble in venture before taking a big step into the asset class. The result is a dramatically differentiated fund with a great investment strategy and investors—mostly retired executives of consumer and retail—who can actually help our portfolio companies, because of their experience in consumer goods and services.
The Downside: Venture Capital Investments Carry Risk
Where there’s the potential for big returns, there’s always fine print. First, a venture capital investment is illiquid—money you won’t be able to access for 10 years, while the fund invests capital in companies, supports growth efforts, and experiences ‘exits’ (generally, when companies are sold to strategic acquirers like P&G or go public). Second, venture capital is riskier than other investment options you could entertain. When you’re trying to innovate and build the great companies of tomorrow, there’s always uncertainty. After all, before the pandemic who could have predicted a sharp decrease in spending on professional apparel?
According to a study by Correlation Ventures, almost 65% of venture capital-backed companies will lose money and ultimately fail to get off the ground. Another 25% will break even, or produce modest returns. The rest, roughly 10%, will be profitable home runs, driving 5x, 10x, even 20x returns. Finally, only about 0.4% of companies will return 50x the original sum invested—a.k.a. the Pelotons, UBERs, and Dollar Shave Clubs of the world—making these returns the exception, not the rule.
For tech-focused funds, the risk profile above is pretty typical, but not one that we’re a fan of, which is one of the reasons we prefer to invest in relatively lower-risk, growing consumer brands. There’s more to investing in startups than finding cool tech or just liking a product or a brand. To reduce the risk for investors and maximize outcomes, venture teams have to have a strategic approach to building a fund’s portfolio.
The Solution: Strategic Portfolio Construction
Careful portfolio construction is critical for reducing investor risk because, according to Modern Portfolio Theory, 90% of your return is driven by your portfolio construction. A venture fund needs about 15 investments in order to be properly diversified—which is exactly what we’re targeting.
There’s less risk as companies mature, with more data points on performance to consider, but the payoffs are generally lower when you invest at a later stage versus an earlier stage. This is one of the reasons we participate in seed, venture, and growth equity rounds.
Generally, we take a Warren Buffet-style, value-oriented and sometimes contrarian approach to our investments. We believe it’s important to zig when the market zags, investing in a sector that isn’t overheated like tech and not buying in when companies are overvalued.
To make portfolio decisions, we look at years and years of category-specific data—comparing apples-to-apples hair care or baby food deals, for instance—to gauge performance. On top of the ability to weigh a company’s potential, you need partners who are subject-matter experts in the domain in which you’re investing. At our fund, we are consumer specialists… so you won’t see us investing in SpaceX anytime soon.
Our partners and investors are experienced consumer executives who have worked with and for some of the biggest names in the consumer field—P&G, Target, Coca-Cola, Johnson & Johnson, Kroger, and more. If we’re looking at a diaper company, we’ll call on Jim Stengel, who led the Pampers brand before becoming CMO of P&G. If we’re looking at an organic tampon, we’ll ask Mel Healey to weigh in, as she spent years running P&G’s feminine care division before becoming President of P&G North America.
The Aim: Invest in Great Companies that Strategics Want to Buy
We always invest with the end goal in mind. We leverage our deep consumer expertise, looking for companies with a new technology, a new customer base, or an attractive sales channel. We look for meaningful brands that we can help grow into $1Bn brands. Within 10 years, we aim to sell those brands to buyers like Estée Lauder or L’Oreal, or in rare cases, have an IPO.
The bottom line is this: Venture capital may be higher risk, but it’s worth considering—especially now, while the market is volatile. And the asset class is accessible to Main Street investors if only you choose the right fund with a reasonable entry point, a strongly diversified portfolio, and a rolodex of subject-matter experts who can help grow each of the companies it invests in.
Lastly, you might be wondering: Aren’t there a few more pieces to this puzzle? How do you source and evaluate investments for a superstar portfolio? We’ll be covering that in our webinar on October 20 at 11 AM, October 27 at 12 PM, and October 29 at 1 PM, so don’t miss it.
You can register for “VC 201: Evaluating Investments” here: https://us02web.zoom.us/webinar/register/4716002853917/WN_5NH00A9QT5GRmyH8FLiy1Q