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Jon Bradshaw & Peter Harris

Learn About the Risks and How to Invest in a VC Fund

How Do I Invest in Venture Capital Funds? (Episode #5)

Learn how to invest in a venture capital fund on today’s podcast.

Peter talks about the risks, pros, and cons of investing in a fund.

As always, investing in a VC fund requires that you’re an accredited investor.

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Episode Transcript

Jon: Peter Harris University Growth Fund. Question for the day How does one invest in a venture capital fund and what fund should I try to get into?
Peter: Well, yeah, this is an interesting topic and there's a lot happening out there today around this. So how does one invest in a venture capital fund? Well, the first requirement to invest in a venture fund is you have to be an accredited investor, which means that you have a net worth of over $1,000,000 minus, you know, not including your your primary residence or your making.
Peter: I think it's, what, over $250,000 a year or something like that, or $200,000 a year or the SCC just revised it. And if you have your series 765 and like 83 licenses, you can also qualify.
Jon: All the Robinhood investors out there right now cannot invest.
Peter: That's right. Because you have to be accredited. And the reason for that is because venture capital is considered a very risky investment. So they have these provisions in place to protect investors from, you know, making these types of investments. The next thing is you need to have a meaningful amount of money that you can deploy into a venture capital fund because the minimums tend to be pretty high.
Jon: What are the.
Peter: Minimums? Well, they vary by fund.
Jon: Can we say what is your minimum?
Peter: So they can vary as low as like.
Jon: So you can't.
Peter: Say what your thousand dollars. Okay. I've seen some funds that are like $50,000, which seems like not a lot of money, but it does seem like a lot of money. Right. Depending on the individual.
Jon: What would like a benchmark be assuming you could get into a benchmark.
Peter: the fund benchmark. Yeah. I mean, their minimum is probably like $5 million.
Jon: Okay. What about a local DC album? Do you know their minimums?
Peter: I don't it, but I would imagine it's probably at least half 1000000 to $1000000.
Jon: So if someone's personally invested in a venture capital fund, assuming, say, 5 to 10% of their net worth max.
Peter: Yeah. So even that would be a lot right to put into one fund. But if you were going to say, okay, I want to allocate some of my net worth into venture capital, then yeah, probably somewhere in the round 5%. Okay. It would be reasonable. Some people go a lot higher than that. They'll go ten, 15% into assets like venture capital.
Jon: What are the risk factors associated with venture capital?
Peter: Yeah. So the biggest risk factors, one, I mean, your venture capitalists invest very risky startups, so you could just lose all your money. The other risk factor I don't think a lot of people think about is that these are long term investments and they are locked up. So once you give your money to a venture capitalist, it's not like you can just call them back up and say, Hey, I'm ready for that money back now because I want to go, you know, buy a house or, you know, I just lost my job or whatever.
Peter: That money is locked up and it's effectively like untouchable until the venture fund has been able to liquidate the investment that they made. And then they they'll give you back a piece of it. Right. And so these funds, they're ten year funds. And oftentimes you may not get your full return on your investment for more than ten years.
Peter: It could be like 15 years. I know funds that haven't fully returned all the capital for 20 years. Right. So that's part of the risk, too, is not even just like I may not get my money back, even if I get all my money back, plus a nice healthy return, it might take me ten plus years for that to happen.
Jon: Okay. Also, there's another risk. It's called the capital gains call. So like, let's say you had the money, the market crashes.
Peter: Yeah.
Jon: You can't put your next commitment in because a lot of times you don't put 100% of your money in at upfront.
Peter: so you miss your capital car. Yeah.
Jon: And then you just lose everything, right?
Peter: Theoretically, yes. That that could happen. So what he's referring to is when you invest in a venture capital fund, it's not like you take that $50,000 and hand it to the fund Day one. What happens is you make a commitment. So over the life of the fund, I commit to invest, you know, $50,000. And then what happens is the venture fund will call you up or send you an email or what have you and say, okay, I'm ready for part of your investment that you committed to make with me.
Peter: Right? So maybe I need 5% of that. So you're going to wire, you know, 20 $500 and they're going to collect that from all of the other investors that committed capital to them, and then they'll make the investment. What happens, though, is that you are contractually obligated to make that capital call. And if you don't make the capital call, there are penalties in place that could result in you basically of all your prior investments, essentially being wiped out, Gonzo.
Peter: So if it's, you know, the first year of the fund and you've only given them like 2500 bucks and you miss your next capital call, then you lose 2500 bucks.
Jon: It's like 25,000 or.
Peter: More. Well, I mean, yeah, yeah, I'm assuming a $50,000.
Jon: Okay.
Peter: Capital. But you're right. Like, if if I'm investing $1,000,000, right, Maybe I've put up like $50,000 so far of that million dollars then. But then I don't make the next capital call. Then I could lose that whole $50,000. Right? They could just wipe it out or they could take penalties out of it. And so the value of it could go down.
Peter: There could be a lot of different things.
Jon: What type of a venture capital fund should I focus on? So like besides yours, University growth fund, it'd be great. A great fund.
Peter: Okay, so here's the thing. In venture capital returns on individual startups follow what we call power law distribution, which means that there will be only a handful of deals in any given year that drive the bulk of the returns. Right. But that also means that if you carry it, the next layer down is that there are a small number of venture funds that generate big, big returns.
Peter: So ideally you'd want to be in one of those big funds. Now the problem with that is that everybody wants to be in one of those funds, right? Large institutions that can write very large checks and have a lot of pull. Right. And so those funds can be incredibly hard to get your foot in the door and get access to if you can.
Peter: Let's say you're an entrepreneur that that fund is backed and you generated a massive, massive return for them. You might have enough leverage to get them to let you put some money into their fund. If you don't have that ability, then what you want to do is be looking for kind of the emerging managers, the up and coming funds.
Peter: In my opinion. You want to do that for two reasons. One, they are hungry for capital, right? They're brand new funds and they're trying to get their fund off the ground. And so they'll take money from pretty much anybody that they can get it from, so you can get good access. The other thing is emerging managers tend to be really hungry, right?
Peter: And they've got a lot to prove and they need to be able to generate good returns in their first couple of funds in order to grow and get big enough so that the larger institutional investors will be willing to invest in their funds. Right. And so oftentimes, like the data shows that emerging managers can outperform more established and seasoned managers that said, it's also very risky because these are brand new funds.
Peter: They don't have much of a track record that they can point back to. And so there is risk that they could lose all of your money or lose some of your money. and so you have to take that into consideration as well.
Jon: Okay. Are there other models besides venture capital funds I should consider? Are there other models? NVC that I should consider?
Peter: So I think investing in some of these equity crowdfunding platforms can be a great way to get exposure to startups. So another thing that you could do is participate in initial coin offerings, which in a roundabout way is kind of backing a startup. You know, I.
Jon: Think legalized gambling, in my opinion, Yeah.
Peter: It's very risky. It's very risky, I agree. But it is another model that you could look at. Other alternative investments would be like real estate investing in hedge funds.
Jon: Is the current ICO model one where they're time. When the ideas were super popular, they said, Here's my ICO, which is separate from my company. Yeah, And to me that seemed like a complete fraud. But the founders, you said they found some way to tie the two of them to me seemed much more genuine and at least much more palatable and less gambling ask ish.
Jon: Would that be fair to say?
Peter: I think the other problem, though, with a lot of ICOs was that it was like they had an initial coin offering because it seemed like an easy way to raise money, not because it was actually core and made sense to their to their business model. Right? So that's one I think the ones that were able to demonstrate like really core fit right, actually have done fairly well.
Peter: Not all of them, but but many of them. I think the other issue with the initial coin offerings was it felt a little bit like a Ponzi scheme in that you'd have people who would come in early and then they would do the initial coin offering and those people would all be able to like get a huge return right off the bat and liquidate and be out.
Peter: And then they, you know, you didn't help and support. It was like totally pump and dump. Yeah, you're the.
Jon: Crypto pumping dumpers and you had the penny stock pump and numbers.
Peter: Yeah. So you have a lot of people holding the bag at the end of the day which which made it risky.
Jon: All right. Well, thanks for watching, guys. We hope this answer your question on, you know, how does one invest in a venture capital fund? So stay tuned for next time. Make sure you like and subscribe and you can find us down below. Peter EGF after links will be in the bottom. And thanks for watching.
Peter: Thanks.