“WHAT A STRANGE WORLD WE LIVE IN…”
– LEWIS CARROL, ALICE IN WONDERLAND
Like all investing, successful venture capital investing is about buying low and selling high. But venture capital investing offers another valuable benefit too, that it is non-correlated with other potential investment opportunities.
Non-correlated investments move in directions unrelated to the price movements of other investment asset classes rather than in unison with them. Regardless of how valuations of other assets are moving, venture capital investments can, and often do, move all over the place: up, down, sideways, forwards and backwards. The key, of course, is that at its exit, a good venture capital investment winds up at a considerably higher price than at the beginning, resulting in a significant financial gain.
Forecasting the precise timing of successful exits is almost impossible. For a start-up or early stage investment, five to ten years is the likely duration to an exit, but the exact moment and exit price are highly uncertain. Price, according to Henry David Thoreau, is how much of your life you must give up for something, and that is often how both a start-up entrepreneur and a venture capitalist experience exit pricing. Often, the more time invested, the higher the multiple on exit. The duration of the investment is often correlated with the final exit price, but that exit price is non-correlated with other potential investment opportunities.
If an investor is making or has made a number of other asset class investments such as stocks, bonds, real estate, or art, a venture capital investment can often add additional value (or mitigate risk) because it is non-correlated with those other assets. Whether those assets move up or down in value will have little impact on the venture capital investment, which may even often move in the opposite or near opposite direction.
One of the major reasons a venture capital investment is non-correlated is that it generally has little or no value until it is either sold or taken pubic in an initial public offering. Until this final exit, it is difficult, and sometimes impossible, to assess a fair value for many ventures, and so, while some holders of venture investments may adjust the values on their books, many venture capital firms may not even try to write up or down the book value of the investment unless it is viewed as worthless.
Moreover, since the exit may occur at any time, the exit value is often not related to how stocks, bonds, or other assets are performing. Being non-correlated can be of real value to an investor, as the cash from the exit can be deployed advantageously at a time when the value of other investment opportunities is down, or it may help avoid the need to sell other assets at an unfavorable price for liquidity.
Venture capital investing has this duality – its exit price is both correlated with time (i.e. investment duration), which lends it a certain predictability, and non-correlated with other investments, which can render its exit price out of sync with other assets. It is this duality of the correlated and the non-correlated that gives venture capital investing a uniquely valuable and often under-appreciated place in an investment portfolio.