There are around 2,000 venture capital firms managing about 4,000 funds. It’s a small market in the grand scheme, but many aren’t worth investing in. The return difference between the top 25% and bottom 25% is staggering.

This is a game of professionals. It’s no different than elite athletes competing at the highest level in professional sports. The same separation of talent exists in the venture capital arena. Investors with the best access look for 5x or more in returns.

What else does it take besides capital to invest in venture? Are you an accredited investor or a qualified purchaser? Are you investing as an individual or an LLC? Are you making directs, allocating to funds, or even diversifying into a fund of funds strategy? Justin and Brandon give you the details on how the whole process works.

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EPISODE HIGHLIGHTS:

(1:02) How do I find the next all-stars and Hall-of-Famers in venture capital?
(1:45) It is difficult to find the best-performing managers, funds, and even more so portfolio companies. And you are only rewarded if you can get into the best ones.
(2:18) There is persistence in the data. This means the best managers in VC are able to repeat their performance. This is NOT like the public markets and their managers.
(3:03) A different ecosystem in the venture space creates the opportunity to keep outperforming. Informational asymmetry and access to top-tier networks are the most significant drivers of persistent returns.
(3:32) Is a VC manager going to keep outperforming his competitors?
(3:55) Just getting access and an allocation to the small group of winners can be extremely difficult.
(4:50) If someone is banging down your door to invest in their fund, that’s a red flag. The best funds returns speak for themselves and don’t need to search for capital.
(6:40) When you finally decide to invest in a fund as a limited partner, what happens then?
(7:00) You must be an accredited investor and many of the top funds require you to be a qualified purchaser.
(7:16) Next, you need to read and sign a lot of documents including an operating agreement that establishes the role of the general partners.
(8:08) A lead investor or anchor investor is the person or group that takes the largest stake. They help negotiate and establish parts of the partnership agreement.
(9:16) How are you coming in to invest, are you an individual, trust, or LLC?
(10:12) What is a fund of funds structure? A fund that can get access and diversify into many different VC Funds.
(10:49) Trade-offs for fund of funds are possibly lower rates of return because the diversification caps your upside on the winners. The expenses also reduce returns to you the investor.
(11:40)Venture capital funds look to return 3x to their investors. To get that kind of return with the fees charged, VCs must find companies that can do greater than 10x before fees.
(13:56) Venture capital’s return profile is called a J-curve.
(15:32) In a perfect scenario, the venture investment turns into a hockey stick and goes mostly vertical before the exit.
(16:00) What are the fees in venture? Usually 2% of committed capital and a “carry” of 20% of profits on the exit.
(17:11) A $9M appreciation in a portfolio company would deliver $1.8 million to the VC and $7.2M to the investors. This is the carry and why so many smart, competitive people are in the space.
(18:22) The best VC firms can be selective with who they allow as limited partners.
(18:44) Just being a professional athlete is not enough to get an allocation to top VC funds. What else do you bring to the table to help achieve a successful outcome?
(19:04) If you’re an athlete can you provide a unique way to add value to venture firms?