Fun, variety, and excitement. If these words strike a chord when it comes to investing, perhaps venture capital is for you.
What is venture capital?
Venture capital (VC) is a form of private equity and financing that investors provide to start-up companies and smaller businesses that are believed to have long-term growth potential. VC generally comes from investors, investment banks, and other financial institutions. This is typically an institutional investment. VC enters to finance growth as the business goes into a phase of expansion and offering improvement. Investors are no longer a single individual but a team of experts working together.
Typically, private equity (PE) takes over as the business enters more stable growth; the main differences between VC and PE are the size of the investments (more significant in PE) and the expected return multiples (higher in VC).
The final stage is when the company, in some cases, goes public in an IPO. Obviously, the funding journey varies from company to company. For a long time, access to these investments has been harder for non-institutional investors. Klint Ventures is breaking that mould.
Image: This extract from Pitchbook which highlights the typical top 10%, top 25% and average returns you would expect to see from VC portfolios. This is assuming an initial EUR100,000 investment.
Venture capital as a diversifier
Venture capital can be an appropriate addition to a portfolio, in part, due to the potential of VC to deliver higher returns than other investment opportunities.
In addition, as more start-ups stay private longer or don’t go public, VC has become a more important strategy for building a diversified portfolio. As we have seen during 2021 and 2022, having access to certain alternative assets protecting on the downside and providing upside potential is an important consideration.
Risk vs. Return
Investing in venture capital carries an element of risk. Unlisted companies in the growth phase are at higher risk but potentially higher returns. That said, if a business develops according to plan, the risk associated with it will decrease whilst, at the same time, company value starts to increase. Many of these changes – the relatively sharp business risk decrease and the rather sharp company value increase – occur during the VC phase. No wonder that, if you’re really good at identifying the right cases at the right time, VC is an extremely exciting investment window.
This extract from Pitchbook highlights the typical top 10%, top 25% and average returns you would expect from VC portfolios. This is assuming an initial EUR100,000 investment.
Image: Pitchbook Global VC 2020, fund vintage 2014-18
Looking at the top 10% of venture capital investments, this creates an exponential performance with in excess of 5x in 5 years and, based on these numbers, 30x in 10 years.
Looking at the top 25% of venture capital investment, this too creates significant wealth creation, with in excess of 3x in 5 years and nearly 10x in 10 years.
In almost all cases, VC investments are illiquid, which in turn implies increased risk – not being able to get out of an investment at your own will is a risk factor. The more liquid your VC engagements, the larger the share of your portfolio could go into this investment class. That said, given the intrinsic relative risk of VC investments, experts typically recommend the VC part of a portfolio to stay in the range of 5-10% for private investors and a bit more for institutional ones.
VC is a fascinating company phase and investment focus for numerous reasons:
- Risk down, value up. Risk decreases and value increases are typically fast and correlated;
- Scalability shows itself – if it’s a scalable business model, this is the time when it truly starts kicking in;
- Leaves one-person dependency – as the company grows, it becomes less dependent on one person/founder, but rather an entire team;
- Hidden nuggets – as a VC investor, there are numerous companies to choose from – if you know how to source, you can find true gems;
- The right investor can further accelerate growth. If the VC company is business savvy, its knowledge can significantly help accelerate the business, leading to outperforming returns. So-called smart money goes a long way;
- It’s fun – the VC phase is often when the unicorns of tomorrow will show themselves, making it extra exciting as an investor. It’s also a way to keep informed and updated with the latest technology trends and outlooks for the future. Seeing the development of future unicorns with the potential to disrupt whole industries is, for many investors, the true passion!
As a Nordic-focused VC, our HQ in Stockholm, Sweden, is a hotbed of entrepreneurial innovation. Second only to Silicon Valley, Sweden, per capita, is the world’s strongest Unicorn (start-up reaching > 1bn USD valuation) factory, with successes including Skype, Spotify, Klarna, Mojang (Minecraft) and King (Candy Crush).
Investing in only one company isn’t a great strategy when it comes to sensible risk management. Bundling to diversify risk is highly recommended, as it’s likely that a small part of all investments will account for a large share of total profits made (the so-called power law). This is where our proven expertise and active involvement come in.
When we invest in companies, we invest in its founders.
Choosing companies to invest in is based on skill and team knowledge that we’ve developed and fine-tuned over many years. Founders wear multiple hats and fill various roles – from business development, finance, and marketing to product development and people management.
What, in our opinion, makes a good founder?
- Product execution
- Team player
- Great communicator
It is nearly impossible to be a superhero founder and outstanding at everything. An essential skill for founders is knowing where they excel and ensuring the team that surrounds them compliments and is strong in areas where the founder is not.
All of the above areas are important. That said, three areas where we personally highly value and consider key for founders are:
- Dedication — starting and growing a company is not a 9-5 job. The founder(s) should live and breathe the business and have a constant interest and passion in driving it forward.
- Focus — the company needs to build a competitive offering to develop fast and build something new and robust. It is difficult if the solution is broad rather than deep. Inspiring the team to channel its energy on the essential parts of the product/solution and to ensure they do it in a focused way.
- Grit — there will be great days and weeks but also challenging periods in the fledging days of a company. The founder(s) needs to push through the tough times and inspire the team, partners and customers no matter the challenges.
A superhero founder is a fantasy, but a superhero DFG (Dedication, Focus, Grit) founder can be a reality. We hunt out and support these individuals and their businesses. Our future industry leaders.
Dean Kemble, Klint Ventures
Klint Ventures is an innovative investment company passionate about making venture capital accessible, intriguing, and enticing by bringing primarily Swedish and Nordic tech-enabled companies to international investors. As Klint Ventures is not an investment fund, it has a more dynamic and flexible mandate with no fixed end date or lock-in period. This is a good structure for the long-term relationship with the portfolio companies we prefer. Klint Ventures is committed to active ownership in our portfolio companies.