By Nick Callais

Why Invest in a Venture Capital Fund Vs. Go Direct?

Many accredited investors and families often ask: Why should I allocate to a venture capital fund when I see enough deals and I don’t have to pay fees?

Investing into a professionally managed venture capital fund increases the chance of success in most circumstances. Ad hoc investing in early stage opportunities tends to lead to inferior returns due to specific risks that venture capital vehicles focus on mitigating and addressing. We launched Callais Capital Ventures to provide a layer of focused institutional capital to increase the chance of success for quality start-ups and startup investors in our covered region and to specifically help address the following hurdles that face individual investors who want to invest in early stage growth companies:

1. TIME:

Individuals rely on their spare time to find and manage startup investments. Most individuals who play in venture have other operating businesses and commitments.

VCs are dedicated each and every day toward sourcing, reviewing, negotiating, growing, and exiting startups. VCs also have a process for getting to a YES or a NO for initial investment as quickly as possible through standardized tasks, approvals, timelines, and set due diligence questions that identify major startup problems at the outset that would otherwise take significant due diligence on behalf of an individual and may lead to significant issues for the startup after they invest.

2. DEAL FLOW:

Individuals rely on incoming deal flow from limited sources – often within a few set industries that the individual has professional experience within in a limited geographic area. A question that should be considered on every opportunity is why am I seeing this deal? How many other people have passed on this opportunity before it came to me?

VCs almost always see these same opportunities for early stage companies in advance and are likely to see 10 more just like it within a few years through a combination of outreach efforts and inbound deal flow from a broad network in the startup ecosystem composed of accelerators, incubators, earlier and later stage funds, universities, EDOs, existing portfolio companies, service providers, and others.

3. INFRASTRUCTURE:

Individuals tend to rely on their network for advice before investing. After investing, engagement is often limited to occasional calls with management and reading quarterly emails. 

VCs operate purpose-built organizations to specifically source, choose, negotiate, report on, and manage deals. VC firms like ours access  relevant data research tools, industry software, best practices, internal task management, and ongoing management of data, budgets, and goals after initial investment which enhances portfolio company monitoring, advice for startup leadership on strategy, and ultimately improves chances of success. This startup support infrastructure provide significant value for limited partners, prospective companies, and current portfolio companies that can’t be easily replicated. VCs often maintain a network of highly skilled executives, functional domain experts, and partners who are at the top of their field in software development, marketing, finance, recruiting, executive reporting, and other areas that can assist portfolio companies as they approach opportunities and work through issues. These functional expert partners can be leveraged across the portfolio of companies pre and post investment as circumstances arise.

5. EXPERTISE:

While individuals often have experience and deep relationships from their career and networks, it is often focused around a particular industry or geography. They rely on their own ability to pick and manage deals.

VCs hire team members with resumes and skill sets that will help them excel at finding, negotiating, and managing early stage venture companies. These team members often have significant networks and career experiences in building previous companies, in finance, due diligence, negotiation, structuring, and adding value for entrepreneurs after initial investment.

6. ACTIVE VS. PASSIVE

Individuals rely on management teams and tend to be reactive to company issues. They are often told about execution issues or cash needs as they occur in a more reactive fashion. In financing events, individual investors often aren’t leading the financing round and in a position to price and negotiate terms.

VCs are actively engaging with their portfolio companies often as members of the board of directors and via certain control and information provisions attached to their investment. They are often directly responsible for negotiating the financing terms in a capital raise. Through consistent information flow, internal analysis and experience, VCs are in a position to identify issues before they occur in many cases. VCs enable startup founders to execute on their growth plans while providing value add support such as recommending talented executives and offering corporate best practices to help outmaneuver competition and accelerate growth.

7. FOLLOW ON CAPITAL NEEDS

Individuals are often the only party who are in a position to continue to fund the firm if the company needs more capital for a variety of reasons. Often financing events aren’t completed strategically in a way that will help the firm in the medium term.

VC funds love to see additional VC groups fund each deal with them. Not only does this de-risk the deal for all parties with more capital in play initially, but if a bridge round is needed, the risk doesn’t fall on only one party at the table. In fact, many venture funds reserve capital to handle follow on financing events for their portfolio companies. These rounds are often completed in thoughtful ways that will set the companies up to potentially attract future capital at industry expected terms. Additionally, VCs can help prevent capital structure issues from being created that may hinder future investors.

8. PORTFOLIO CONSTRUCTION AND ALLOCATION

As an individual investor, it’s challenging to spend a lot of time creating a portfolio of illiquid investments that takes into account the distribution of the types of companies, the areas that they operate, the stage of investment, the unique potential growth profile of each opportunity, or the industry and other related risk categories. By investing in illiquid startups with significant risk profiles, its ever harder. The ideal for many investors is to create a diversified portfolio of risk assets that meet your personal objectives without taking on significant risk in individual allocations based on your horizon and expectations.

For startup investing, like stock picking, its critical to be diversified. These are smaller companies that demand a higher risk premium for investors and to build an ideal portfolio of illiquid companies is a challenge.

The principal element of VC investing is that you will have some selected companies that fail, some float along as a “Zombie” where they neither grow or fail, and others may succeed. You diversify and allocate capital accordingly and deploy it strategically. Overall, venture capitalists hope to have more hits than misses and they attempt to de-risk startup investing in a number of ways by managing initial investment size and the above-mentioned ways. Additionally, VCs look for common indicators of success and failure to de-risk each investment. You need to find experienced fund managers who are able and capable of sourcing, choosing, and investing in the best deals in their market. And even with the best managers, success is not guaranteed like in any investment. The way that you are successful in early stage investing is to manage risk in a structured way.

9. NETWORKS

Individual Investors always have impressive networks and relationships often within their region or industry.

VCs have purpose built national networks of other potential investors, startups, potential acquirers, startup resources, venture arms of corporations, service providers, universities, EDOs, and potential talent networks built over their career to help their portfolio companies become successful and have the resources needed to succeed. VCs may be able to introduce their companies to potential customers and acquirers down the line (more below). VCs continue to nurture these networks to maximize their value add to portfolio companies.

10. ABILITY TO EXIT

VCs build the network above to help their portfolio company shareholders exit when the time comes. These relationships are built through meeting, investing alongside, selling to, and previously exiting past companies to major corporations and other financial buyers. While individuals may have great relationships and networks, the depth of relevant VC networks provides significant value for their portfolio companies to exit and get in front of the right corporate and financial prospective buyers.

Paying fees is never fully comfortable or fun, But it makes all the difference. It’s not about what you are losing, it is about what you are gaining. Venture funds generally strive to hit double digit IRR figures and the fees paid enable this infrastructure to support companies and align venture fund managers and investors toward success.

Does paying fees to professional VCs increase the likelihood of wealth creation and success vs. directly investing personally in companies? I believe strongly that yes it does!

Disclaimer: Investing in early stage companies and funds can result in a full loss of your investment. Please consult your financial advisor if venture capital and early-stage company investing is appropriate for you given your own investment goals and risk tolerances. This article is meant to be informative and does not constitute investment advice and is the opinion of the author alone.