Venture capital firms raise funds that aim to invest capital in startup companies. The goal is to generate outsized returns by identifying and investing in the most promising innovative companies and profiting from a successful exit event. With the proliferation of digital platforms like DarcMatter, opportunities to invest in VC funds are starting to open up to a wider investor audience. Investing in venture capital enables an investor to leverage the deal-sourcing and portfolio selection capabilities of fund managers. Additionally, these investments are generally uncorrelated to the markets and provide an illiquidity premium due to their long-term nature. So what evaluative criteria should an investor consider before investing in a VC fund?
1. General Partner Team: Venture capitalists always talk about how they look for exceptional management teams when they make investment decisions in startup companies. Investing in VC’s is not so different in this regard. By investing in a VC fund, you are investing in the qualifications and talent of the GP. Examine the backgrounds of the investment team. Is there a mix of financial practitioners, industry experts, or former successful entrepreneurs? If the fund is geared towards a specific focus like early-stage technology, does the management team have the appropriate technical knowledge to evaluate the opportunity?
2. Track Record: Prior success does not guarantee future returns with any investment strategy or asset class. However, track record is an important gauge in qualifying venture capital fund opportunities. The cream generally rises to the top, as the top VC’s often get access to the best startups at the most favorable valuations. Subsequently, these VC’s earn top returns. This creates a virtuous cycle in which the VC’s with the best historical track records are the most in demand and earn the highest returns. Prior investment experience is all too important when evaluating venture capital fund opportunities. For instance, a VC partner who was previously a successful angel investor or worked at an established VC firm will have experience evaluating opportunities and selecting winners. Emerging managers also represent an exciting opportunity in that these managers might have the same investing experience as established VC’s but are typically more nimble. Leaner and with more to prove, emerging funds often exhibit a greater drive to generate successful results for clients.
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3. Strength of Network: Track record and network go together. Venture capital firms with the best track records inherently cast the widest net by being in high demand from capital raising entrepreneurs. In this respect, an established VC will have an ear to the ground in hotbed locations like Silicon Valley, New York, Israel, South Korea etc. Perhaps certain VC’s have unique business relationships through their industry relationships. Regardless of the VC’s particular strategy or niche, industry expertise and deal-sourcing capabilities are important aspects for an investor to evaluate.
4. Operational Fluency: VC’s are businesses and need to be run as such. Similar to investing in startups, execution of the business plan requires a full range of operational expertise. Important aspects for VC operations include the ability to structure deals, negotiate terms, and allocate capital. The expertise of the venture capital firm’s legal, finance, and investment sourcing teams should not be overlooked. Investors should evaluate how well-oiled the operations are at a VC before investing in abstract ideas or technologies that are hard for the layman to understand.
While these are not the only factors and qualities investors should look for when evaluating investment opportunities in venture capital firms, it’s important for investors to do a comprehensive due diligence. Provided the increasing interest and demand in alternative investments that’s coming from investors, there’s opportunity to invest in VC funds through digital platforms. It is extremely difficult for an investor to source deals without significant capital or the appropriate network. By facilitating transparency and informational access to many fund managers, platofrm such as DarcMatter provide investors with the opportunity to evaluate VC fund opportunities and ultimately invest in this asset class.
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SEE ALSO: 6 Questions to Ask Before Investing in a Hedge Fund
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