Which came first? The venture fund or the track record

Track record

The venture capital segment of private markets has always been uniquely different to other asset classes, whether it be the ability to tap into venture scouting networks to influence investment returns, or the radically different return profile that VC can deliver.

One such difference – which is a substantive one – is the difficulty of building a track record in venture capital.

The necessity of a track record to raise a fund

A venture capital fund is a classical type of pooled investment vehicle, where a Fund Management team raises capital from investors – traditionally known as ‘Limited Partners’ – and invests in technology startups or early-stage growth companies on a discretionary basis.

That is, to say, the venture capitalist makes the ultimate decision to invest in a technology startup, unlike the deal-by-deal investments model facilitated by SPVs, where the underlying investors decide whether they would like to participate in the underlying opportunity.

VC funds are ‘closed-ended’ funds, the capital that the underlying LPs ‘commit’ for the fund is locked for a defined period of time (typically seven years extendable by three, or ten years extendable by an additional two). Thus, LPs need to carefully select which venture capitalists they will back, to ensure that their scarce investment capital is put to good use.

Alongside work experience, whether it be as an ex-investment banker, an ex-founder or a former Principal at a venture firm, the investment track record is a major metric to determine how likely a venture capital firm is to deliver outsized returns.

This point is particularly salient in the case of institutional investors (such as government-backed development banks), where not only do they want to see individual work experience and track record, but also the ability for the core Fund Management team to work together.

Team cohesion matters when capital is locked up for a long period of time, as illustrated by a recent collapse of a venture firm caused by a power struggle amongst its GPs.

Chicken or the egg?

A track record is uniquely difficult to demonstrate in the context of venture capital.

By way of comparison, if you were looking to show your ability to navigate public markets, you could set up an account with a discount broker, and use your ‘live’ performance statements as some indication of a track record.

Whereas for venture, historically it was very much zero-to-one. You either have a venture capital fund with which you can demonstrate performance, tracked via metrics such as IRR and TVPI, or you don’t.

Dealflow (and access to hotly-contested rounds) is another aspect which is difficult to display in a live situation.

It takes a unique blend of skill, charisma, luck and being sufficiently well-connected to place yourself in a situation where you can join in on such an investment round.

The question of track record is therefore, putting crudely, essentially a chicken-and-egg situation.

Did the chicken come first?

Or the egg?

Egg. Track record. Chicken. Venture fund. Cluck cluck...

Individual angel investing as the first step

The late 2010s heralded a new way of demonstrating track record as a budding venture capitalist – the emergence of angel investing as a mass phenomenon.

Everyone is an angel investor now. 

Whether it be the new generation going from trading options on Robinhood to backing companies on crowdfunding platforms, or investment bankers and startup executives investing with friends and colleagues on the side – this trend serves as a good way to exhibit ‘live’ performance.

Moving towards a syndication model

Whilst angel investing on an individual or grouped basis is the first step, it does come against some limitations.

For starters, technology startups prefer to have a ‘clean cap. table’, which means that they are less receptive to individual angel investors with small(er) ticket sizes investing directly.

Part of this has to do with operational efficiency – dealing with tens or hundreds of shareholders directly – is a ‘mental charge’ levied on the Founders, but also to do with institutional investors' preference.

This means that angel investors are put in a situation where they will need to either:

(1). Have a concentrated pool of angel investments (with higher average investment sizes); or 

(2). Find a way to band together with other angel investors to invest collectively.

A venture syndicate – essentially an investment collective, either formal or informal, can be grouped around a common background (E.g. early employees of a fintech unicorn) or a theme (alumni of a particular MBA programme).

To solve this, the angel investors all bundle into a single SPV, which then slots in as a single line on the cap table of the portfolio company.

Everyone wins – the portfolio company has more capital to play with and a wider shareholding (with investors naturally serving as advocates), and the underlying angels are able to invest small(er) tickets more widely, therefore increasing the likelihood of some investments becoming wildly successful.

From running syndicates to launching a fund

Running a Syndicate, or investing through one, therefore resolves the twin questions of track record and dealflow.

Once an angel investor has made enough angel investments, s/he can then begin talking to cornerstone investors to see if they would back a venture capital fund run by them.

A new era in venture

Venture capital is a rapidly-changing place.

From podcast hosts & influencers who have built  media empires to ‘startup CEOs moonlighting as venture capitalists’, the continued rise of angel investing allows a new, more diverse, generation of venture capitalists to enter the fray.

Bryan Cheung