In my last article, I discussed why individual investors should include privately held, innovation-driven companies in a diversified and balanced investment strategy [Seven Reasons Venture Capital-Stage Companies Should Become Part of Your Investment Portfolio]. In the past, access to these opportunities has been restricted by high minimum investment requirements such that typically only the very wealthiest individuals could participate. Angel investment groups were accessible to individual investors but had (and continue to have) significant disadvantages.
Today, there are new mechanisms for accredited investors to participate in high-quality, privately held investments that previously were not accessible. The available avenues, however, are not all equal. Risks abound. Let's examine and compare five of the channels open to individual investors to access venture capital-stage companies:
- Crowdfunding platforms for startups
- Angel investment groups
- Accelerators / Incubators
- VC funds including alumni funds and micro funds
- Venture creation firms
Crowdfunding platforms for startups
There are numerous crowdfunding sites where young companies of all types can post information about their investment opportunity and investors can review the companies seeking funding. Some well-known examples include StartEngine, WeFunder, and SeedInvest. Investment minimums can be as low as in the hundreds of dollars range, and—as a result—are highly accessible. However, deal vetting and reasonableness of the investment terms vary widely.
|Low minimum investment||Many companies have valuations that do not fully reflect the risks and have other poor terms for investors|
|Many companies to choose from (if you have time to conduct your own substantial due diligence)||Due diligence challenge for the individual investor to sort through large number of companies|
|Lower due diligence standard by the entity; the crowdfunding sites are not putting their own money at risk but rather get a fee and/or percent of raise|
|No ongoing support for invested companies|
|No ongoing protection for the investors in the companies|
Angel investment groups
Angel investment groups are located all across the country. They include regional angel groups, which only invest in companies within a certain region, and national angel groups. A given angel group may be specifically targeting a certain domain (e.g., IT, life science, etc.) or may review investment opportunities from start-ups in any field.
Although there are several well-managed angel investment groups out there, they suffer, in general, from widely variable deal flow quality and due diligence. While sometimes offering better due diligence than crowdfunding sites, most angel groups depend on volunteers to conduct the due diligence on behalf of the group. There are often simply insufficient resources to carry out the needed level of review. For that reason, simpler opportunities that are more readily understandable to the average person tend to get selected ahead of more complex but perhaps much higher upside prospects. Of course, these are generalized statements since the situation varies widely from one angel group to the next.
Most angel investments do not provide sufficient voting control in the invested companies to protect the individual investor's interests during future, larger institutional investment rounds. Stacked liquidation preferences (where later round investors get paid first and sometimes at a multiple) and other later round investor preferences can severely damage the prospects of the earlier investors who invested at a riskier stage with higher expected upside.
|Co-invest with other investors and share due diligence efforts||Lack of sufficient resources to conduct the needed level of due diligence for complex opportunities|
|High number of investment opportunities||Inconsistent deal quality and terms|
|Regional focus that can help the economic vitality of region||Regional focus can limit the quality of the deal flow|
|Opportunity to syndicate with other angel groups||Little ongoing support for invested companies|
|Little ongoing protection for the investors in the companies|
Some accelerators and incubators make startup investments and help the startup teams move forward with training, investor introductions, and more. This is particularly useful for new founders who have never previously faced the multitude of challenges a typical start-up encounters.
Two well-known accelerators are Y-Combinator and Techstars. Every year these accelerators have Demo Days where the companies graduating from the program present to investors. However, these are invite-only so individual investor access is limited. Another issue is that the terms for the investment may not be favorable. Y-Combinator, for example, does SAFE note investments into its graduates. These are company friendly but not individual investor friendly. See my article SAFE vs. Convertible Notes: Which is a Better Choice for Early-Stage Investments for a discussion on some of the limitations of SAFE for early-stage investors.
|The top accelerators are selective and choose from a large pool of applicant companies||Investor participation is by invite only for the better-known accelerators|
|High number of investment opportunities||The success rate of the companies is relatively low|
|More ongoing support available than a typical angel network||Little ongoing protection for the individual co-investors in the companies|
|Deal terms, such as YC Safe Notes, high median valuations, etc., are more company friendly rather than early-stage investor friendly|
VC funds including alumni funds and micro funds
In the past, individual investor participation in venture capital funds was limited to ultra-high net worth individuals. More recently, however, there has been a proliferation of funds allowing participation by smaller investors. These include alumni funds and micro-VC funds (median micro-fund size is ~$10M). A record number of micro-funds were formed in 2021. Overall, while performance data is limited, according to Pitchbook , micro-funds appear to be showing a strong return profile.
A disadvantage to participating in VC funds is the significant management fees typically charged. Another issue with VC funds, in general, is a tendency for herd mentality, where many people are chasing the same deals and driving the valuations unreasonably high. Of course, the same thing can be the case for individual investors, angel groups, and accelerators. Case in point: When cryptocurrency was riding high, the herd followed suit investing in all kinds of schemes—some solid, some baseless—with predictable longer-term results as made clear by the recent dramatic collapse of cryptocurrency valuations. In my view, it's essential to invest based on the fundamentals which, in the case of early-stage life science companies, includes technology differentiation and protection, market opportunity, etc., while having a thorough understanding of the hurdles (regulatory, capital required, market adoption barriers, etc.). A herd mentality often causes investors to overlook some of the weaknesses of a given investment opportunity e.g., valuation relative to future capital needs and dilution.
|Professional due diligence||Due diligence quality varies|
|Typically have a large pool of applicant companies from which to select investments||Most VC funds remain inaccessible to the typical individual investor|
|Smaller funds, while often more accessible to the individual investor, may not be able to participate at a meaningful level in larger, later rounds|
|Smaller funds invest earlier which means there is usually a longer time to first return|
Venture creation companies
A venture creation company is just what the name implies i.e., a company that creates other companies and builds them from the ground up. This includes licensing the technology, putting together the management and development team, and—for some venture creation firms—providing the founding capital. Venture capital firms, in contrast, typically place funding into an existing business and team.
There are several significant advantages that venture creation firms, and investors in the venture creation firms, may have compared to the other avenues available to individual investors to access venture capital-stage investments. Some of the features in general, and more specifically for my own company, VIC Tech, are described in the table below.
|Pros||Cons||VIC Tech Specific Attributes|
|Venture creation firms typically have larger share of equity per dollar invested and, hence, higher return opportunity for investors.||VIC Tech is the largest founding shareholder of every company in its portfolio.|
|Good venture creation firms provide support to their new portfolio companies far beyond what a typical startup has.||VIC Tech provides done-it-before management and complete operations support for all its new companies, as well as on-going support throughout the entire lifecycle of the company.|
|Ongoing entity rather than one-time fund; may have portfolio companies established at all stages of development including later stage, providing investors the possibility of more rapid return of capital.||VIC Tech has a current portfolio of sixteen companies (and growing) at all stages of development, from early to late, and diversified across multiple life science sectors (therapeutics, medical devices, and diagnostics).|
The top venture creation firms have a large pool of technologies and a rigorous due diligence process to select the best intellectual property foundations for new companies to be formed.
|Most venture creation firms are regionally focused which limits the quality of the deal flow. Some have limited resources for due diligence.||VIC Tech has operations nationally, sources technologies worldwide, and has a 16-person opportunity assessment team supplemented by Strategic and Medical Advisory Boards with extensive scientific, clinical, and commercial expertise.|
|Because the teams are placed by the venture creation firm, there are fewer issues with problematic founders and team members who no longer serve a useful role.
|In VIC Tech's model, an interim CEO is placed from within VIC to carry the company through the initial stages of development. Once the company has sufficient traction, only then is a permanent CEO recruited. This is a much more cost-efficient approach that also leads to a higher quality team (e.g., interim CEO is specialized in establishment of the company, while the future, permanent CEO has stronger experience in product launch and scaling).|
In summary, the individual investor has more avenues available to access venture capital stage investments as part of their investment portfolio than ever before. Not surprisingly, there are both advantages and disadvantages inherent with these emerging options. Additionally, the performance varies widely across the entities in each category. However, if you do your homework on who to invest with, and select one with an exceptional due diligence process, then you can add consistent, top-quality deal flow in high-impact, high-return opportunity companies to your portfolio. Doing so can result in added diversification and upside beyond the investments typically made by the individual, accredited investor.
Micro-Funding Opportunity; Micro-funds proliferate in a market where everything is getting larger, Pitchbook April 5, 2022