Investing in venture capital funds: Do your homework first

Investing in venture capital funds: Do your homework first

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Image result for Investing in venture capital funds: Do your homework firstWhile returns are potentially high, risks are high too, and you must have holding power

Investing in a venture capital (VC) fund is not for the average retail investor because while returns can be high at about 20 per cent or more a year, the risks are high too.

The minimum investment amount is usually $1 million for individuals and the gestation period about eight to 10 years. The illiquidity of VC investments means that investors must have holding power and there is no guarantee that the fund will succeed.

But if you have spare cash and wish to increase your wealth while helping other firms to grow, the VC fund is a viable asset class to consider.

iGlobe Partners managing partner Koh Soo Boon says: “Other than the investment return, our investors have the immense satisfaction of walking the growth journey with the entrepreneurs, and watching them fulfil their dreams.”

And the playing field is expected to get more exciting with the recent proposed changes to slim down the regulatory regime for VC managers, which makes it easier for start-ups to get funding.

WHAT IS A VC FUND?

VC is a form of equity financing. Through equity financing schemes like VC funds or equity crowdfunding, you can become a shareholder of a company. These are typically small-scale emerging firms that have high growth potential.

ST ILLUSTRATION: MANNY FRANCISCO

VC investing differs from angel investing, which is a less structured and informal way of making early-stage investments in firms.

It also differs from conventional crowdfunding, which involves financing a project by raising money from a large number of people on the Internet, typically in exchange for various types of “rewards”.

Besides providing funding, VC fund managers work with start-ups to nurture the entrepreneurs, and help them shape their strategies and business models. VC fund managers also make available their networks of investors and business partners to the start-ups and help them identify board members and senior managers.

Usually, a VC fund will apply a rigorous due diligence process to evaluate numerous opportunities before investing in selected firms that fit its mandate.

If its mandate is to invest in technology-related firms, it would consider those with a novel technology or business model in high-tech industries.

The goal is to generate a return through an eventual realisation event such as an initial public offering (IPO) or trade sale of the firm.

IGLOBE PARTNERS

Take iGlobe Partners. This home-grown VC firm invests in early- and growth-stage tech companies here and overseas. Its investments cover three areas – digital media and mobility, Internet of Things (IoT) and health/biotech.

iGlobe is helmed by chairman Philip Yeo, and managing partners Koh Soo Boon, Robert Chew and Tan Cheng Gay.

In July 2010, the firm launched iGlobe Platinum Fund, which then invested in several technology firms mainly in the digital media sector. Over the next 12 months, it will focus on selling its stakes in all of these companies which have grown significantly over the past few years. It says it is on track to achieve returns that exceed the fund’s target gross internal rate of return of 25 per cent per year.

The firm is raising US$100 million (S$139 million) for iGlobe Platinum Fund II, which invests in high-growth-potential technology firms that are seeking to scale internationally.

Launched in late 2015, the iGlobe Platinum Fund II invests in companies which are in the early- to mid-growth stage. So far, it has invested in eight companies – including a unicorn 3D game engine company, Unity Software, and media technology firm Matterport.

The fund term is eight years plus two one-year extensions, and the target internal rate of return is 25 per cent per year.

The minimum investment in iGlobe Platinum Fund II is US$1 million for individuals and US$5 million for family offices. The fund will be closed to new investors by the end of this year.

1. VC management/investment team

The integrity, background and experience of the team are the most important determinants of future success. If there is any doubt about those running the fund, do not invest, says Mr Sam Phoen, co-founder of investment management firm Wateram Capital, which is invested in several VC or private equity funds and direct investments.

Mr Phoen adds that while the past record is not necessarily a predictor of future performances, it can provide hints to investment patterns and behaviours.

There are companies that benchmark VC funds’ performance. For instance, United States-based Cambridge Associates issues quarterly reports on various VC funds around the world.

By referencing Cambridge’s report from September last year, iGlobe would be ranked in the top 25 per cent for delivering consistently superior returns for its iGlobe Platinum Fund.

A fund’s prospectus provides substantial information to help you understand the investment mandate, objectives and strategies, suggests Mr Neo Teng Hwee, chief investment officer and head of investment products and solutions at UOB. “You should ensure that the fund managers will communicate to you regularly and openly on important developments, both good and bad,” he adds.

2. Domain expertise

Ideally, the VC investment team should be domain experts in whatever they invest in, or at least have sufficient knowledge and engage experts to help evaluate potential investments. This is especially important for specialised funds targeting specific industries, says Mr Phoen.

Ms Joyce Ng, a partner at iGlobe, recommends that investors check on how rigorously the VC team vets investee companies. For example, how well does the VC team know the thinking, philosophy, strengths and weaknesses of the founder of the investee company? Does the VC team visit the workspace and check on the financials, clients, investors and co-investors?

In addition, iGlobe’s Mr Chew advises investors to look for “anchors”, such as a supportive ecosystem. “Find out if the VC has strengths in that ecosystem. For instance, investee companies in a VC fund can leverage one another if they belong to the same ecosystem,” he says.

3. Business model of VC

The composition of investee companies in the VC fund is an important factor, advises Ms Ng. After all, different stages have different risks.

She explains that iGlobe’s investment methodology is to construct the fund portfolio, by investing in a mix of early- and growth-stage technology companies.

“For growth-stage investee companies, the gestation to exit is shorter and it will balance with other earlier-stage investee companies that have longer gestation periods and higher risks.”

She notes that with a balance of early- and growth-stage investee companies, the fund manager has a better grip of managing the risks of the fund portfolio.

“We aim for a low loss ratio with the above approach. Ideally, we aim not to lose any investee company through careful selection and nurturing. This is… difficult to achieve, given the fast-changing global technology and business landscape, but we do our best,” Ms Ng adds.

4. Access

A VC team’s success is closely tied to its ability to find the next unicorn – which is a successful start-up with billion-dollar valuations. Unlike publicly traded securities where information is easily available, VC teams need to be able to scour the start-up world to find promising ideas and participate in their funding as early as possible.

This is very dependent on the VC team’s network, especially if its assets under management are small. The wider the access, the higher its chance of finding the next successful unicorn, says Mr Phoen.

iGlobe’s Mrs Koh points out that if the investee company is a promising one, many VC funds would be chasing it. “Some investee companies ask for references and do due diligence on us,” she adds.

5. Fees and lock-in period

Mr Phoen says the fees are less important if the VC company excels in key areas. He warns that investors should ensure that they are comfortable with the lengthy lock-in periods, which are typically at least five years and may extend to 10. The investment period should match their investment appetite, he adds.

Investment fees for VC funds are typically 2.5 per cent for the first five years and 2 per cent for subsequent years. There is usually “carried interest” or a performance fee of 20 per cent after the principal investment amount is returned to investors.

6. Alignment of interest of VC management

In the VC industry, it is important to have the fund manager’s interests aligned with that of the investors, given the long-term nature of investments. Hence, having skin in the game is critical.

One measure is the “committed capital” that the fund management team has invested in the fund. For instance, iGlobe’s team has collectively invested a sizeable amount into its Platinum Fund II based on their personal confidence and assessment of the fund performance.

7. Invest cautiously and maintain a diversified investment portfolio

UOB’s Mr Neo advises investors to ensure that their finances and investment portfolios are able to withstand the loss of their principal in the event that the business does not perform as expected.

“Venture capital fund investments should be part of a diversified investment strategy rather than hold the lion’s share of your investment portfolio.”

UOB says that the bank’s high-net-worth customers can invest in VC funds in two ways – through its partnership with global equity crowdfunding platform OurCrowd or via UOB’s private equity arm UOB Venture Management.

[“Source-straitstimes”]