Venture Capital Done Smartly: Today’s Most Reliable Long-term Growth Option?


As a retiree living off of assets, it’s important to stay well informed, so I pay close attention to the financial press.  I’m befuddled by many experts’ focus on short-term market gyrations.  While the importance of diversification and maintaining sufficient liquidity is clear, I thought we were “supposed to” focus on the long term.  Even Medicare-aged Boomers need to think about the next 20-30 years. And wouldn’t it be nice, even if you’re not “uber-wealthy” (sorry, Uber), to leave a meaningful legacy to your kids and grandchildren and some worthwhile charities?  All that requires long-term returns.

So I don’t worry that much about short-term market gyrations or hedging quarter-by-quarter against every asset class risk.  I do worry plenty about allocating enough to asset classes with solid long-term growth potential, and I’ve come to the conclusion that investing a percentage of assets in venture capital . . . done smartly . . . may be the most reliable option for long-term growth.  More later on what’s meant by “done smartly.”  First, let’s discuss the overall conclusion.

Traditional Economic and Investment Prognosis: Grim

I find the current state of financial markets and economies worrisome.  The S&P 500 stands now at 1946, 9% below its peak close four months ago, yet Yale Professor and Nobel Laureate Robert Shiller still thinks the market is over-valued.  Meanwhile, bond rates remain at historical lows, six years after the end of the big recession, meaning their prices (which move inversely to interest rates) have nowhere to go but down.

That’s the short term.  Even more disconcerting are economic prospects for the long term, which are fundamental to long-term returns. Six years after the worst recession since the Great Depression, US GDP growth seems stuck at just 2%.  Despite China’s sizzling growth for several years, global GDP growth has been trending lower through the decade, now at just 2.5%/year, a full percentage point below its pre-crisis level . . . and suddenly the Chinese growth miracle has stopped as well.  It’s a struggle just to find Western Europe’s economic pulse.  And in Japan, nothing Prime Minister Abe has tried has revived its economy, and equities are at just half the level of 1989 . . . 26 years ago.  Could that happen in Western Europe or the US too?

While the Fed finally seems ready to raise short-term rates, they’re agonizing over a ¼ point bump after 7 years of near-zero interest.  More than half the cash held by US companies is currently invested in others’ investment-grade corporate bonds. That’s quite an endorsement of their own prospects! In most of the world’s developed countries – the US, every major country in Europe, Japan, South Korea, even China and Russia — the average woman has fewer than two children.  So who’s going to drive those long-term returns for us aging Boomers?

Venture Capital to the Rescue!

The answer seems to me to be entrepreneurs building new innovative ventures. In other words, venture capital investment . .  . done smartly.  Why the belief in venture capital . . . by someone who never invested in venture capital until this year?
To anyone who thinks all the big opportunities are gone — after all, we already have Facebook, Google, and Uber — it seems inconceivable that there won’t be a continued flow of life-changing innovations.  The technological infrastructure in place should make further innovations easier and more numerous.  Even if the overall economy remains flat, those innovations will still generate wealth, while the value of existing products or commodities may decline.

Early stage VC returns are strong

Source: Batterson Venture Capital analysis; early stage index compiled by Cambridge Associates.

Of course, even venture capital goes through cycles, as areas of innovation and investment focus change and as the flow of dollars into new ventures rises and falls.  About 30 years ago we saw venture capital dollars flow into personal computers, spawning the likes of Apple and Dell.  Then came the era of the Internet, bringing innovations like AOL (once valued at $164 billion!) and Yahoo.  Then came innovative applications of digital technology, such as Facebook and Uber.  This continuous flow of technologies and innovations explains venture capital’s outstanding long-term returns history

Importantly, there WILL be more to come, like “the Internet of Things,” value-added advances in data mining, data storage and security, and biotech-enabled drugs . . . and inevitably categories we can’t even yet imagine.

Investing in Venture Capital: The Importance of Being (Earnestly) Smart

Now here’s what I mean by “done smartly.”

  1. Get in Early. Early stage deals seem to offer much greater growth opportunity than late stage deals. I stay away from the unicorns, those ventures already valued at $1 billion+.  With all due respect to Uber and Airbnb, while they still are privately held ventures, their valuations are already sky-high.  Latest round investors paid through the roof.  Maybe those latest round investors can still win, but the “wrong” legal rulings about Uber drivers’ status (employee or independent contractor) or the regulatory issues around Airbnb rentals could destroy value in a heartbeat.
  2. Diversify. This is essential.  Success odds for any early stage venture are a long shot.   Historically only about 20% of ventures succeed.  A small number, though, succeed big, paying out 10, 20, or more times your investment, so you need to place enough bets.
  3. Be Selective. Adroit deal selection – rigorous screening and due diligence – can make a big difference.  While it’s still too early to judge today’s equity crowdfunding sites offering dozens to even hundreds of deals, they seem too much like random lotteries relative to the disciplined selectivity of traditional, professional venture capital firms.
  4. Be Patient. Venture capital investment is a long-term exercise.  You should expect to wait 5-10 years for a payout.  If you think you may need the money sooner, put it somewhere else.

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