How we analysed 1.5m data points to build a VC fund that co-invests with some of the best tech investors
The problem with traditional VC funds.
The job of a fund manager is to spot the Next Big Thing for investors.
This process typically involves reviewing hundreds of business plans each year. They’re trying to find a handful of startups that they believe have the highest potential for growth.
But there’s a flaw with this approach: there is no magic bullet to predict startup success.
There are simply too many random variables involved to consistently pick future “blockbusters” based on information available at seed stage.
So, what are the early-stage investment strategies which actually stand a chance of generating a decent return?
Data suggests randomly investing in 30 startups could actually outperform most VCs.
In 2011 there were 506 startups that raised seed or venture equity finance, for which reliable data was available. This includes now-household names like TransferWise and Nutmeg.
The cohort of 506 startups grew in value at an average rate of 28% per year between 2011 and 2018 (compound annual growth rate, or CAGR).
Our data also followed the 2011 portfolios of 479 VCs, which together grew at 19% CAGR. This suggests that most venture capitalists would be better off picking their investments at random, rather than trying to pick the ones they think will be successes.
Of course, most doesn't mean all. Some VCs are seeing up to 90% CAGR on their 2011 investments; one way to bolster your portfolio could be to access the networks of VCs and angels whose portfolio growth outperforms that of the cohort.
Could you outperform the market using radical diversification?
After carrying out repeat simulations of various investment strategies (100,000 simulations per strategy), we found that one of the most successful was to spread your risk among as many companies as possible.
We dubbed the strategy: radical diversification.
Radical diversification focuses on making at least 30 investments into companies raising between £500,000 and £5m. These simulations assume that a fixed amount is invested into a single round of each company, with no follow-on investments being made.
Average total returns over seven-year
period when investing in £500,000–£5m rounds
On average, such a portfolio returned 3.7x of the initial investment in total over a seven-year period; when diversifying even more dramatically into 80 companies, this figure returned 4.7x.
Radical diversification continues to hold true when applied to smaller rounds of early-stage companies (£150,000–£2m), though the rate of return slows once the portfolio reaches around 30 investments.
The assertion that higher returns are more likely when investing in larger, later-stage rounds is nothing new, since the businesses raising these larger rounds have already undergone the smaller fundraises and survived to raise again.
“Diversification is the only free lunch in finance”
Harry Markowitz, famed economist and Nobel Prize winner
How we used this data to build a tracker-style fund for startups.
Our research suggests that blockbuster companies tend to have been funded by well-networked investors whose performance beats the market.
Many promising investment rounds get taken up by big angels and VCs, and never make it down to retail investors, who by definition offer businesses smaller sums of capital. This can lock you out of their rounds completely and thereby limit the performance of your portfolio.
We used data from Companies House and independent research firm Beauhurst to identify the UK’s top-performing startup investors (based on their IRR) and track the investment behaviour. These are the UKs “super angels”.
With our new VC fund, Access EIS, we have agreements in place with 40 of these super angels to co-invest alongside them in their deals.
Our super angels’ past investments include:
- Horizon Discovery (£221m market cap)
- Magic Pony Technology (sold to Twitter for a reported $150m)
- Swiftkey (sold to Microsoft for $250m)
- Household names like Secret Escapes, Bloom & Wild, and Simba Sleep
Access EIS aims to diversify your investment across at least 50 super-angel-backed startups to minimise risk and capture as many potential “blockbusters” as possible.
As an EIS fund, eligible investors in Access EIS could benefit from generous tax relief on their investment via the government-backed Enterprise Investment Scheme. This includes 30% income tax relief on their investment for eligible investors.
Disclaimer & Risk Warning
Investing in startups is high risk and while our investment strategy addresses many of the risks, you may not get back the full amount you invest. It is important to seek advice before making an investment decision.
These materials are written and provided for general information purposes only. It is worth remembering that while a significant study for the industry as a whole, this report nevertheless uses a small sample size which limits the reliability of assertions drawn from the data.
The content is solely the opinion of SyndicateRoom and/or other contributors and research from third parties. It should not therefore be relied upon in making any investment decisions.
You should not invest in any investment product unless you understand the nature of it, along with the extent of your exposure to risk. You should be satisfied that any product or service is suitable for you given your financial position and investment objectives. Where appropriate, you should seek advice from a financial advisor in advance of making investment decisions