Now Is the Time for Advisors to Put Clients in Venture Capital: Opinion

Last September, SEC Chair Gary Gensler told the U.S. Senate that crypto was like “the Wild West…before securities laws” and The Wall Street Journal reported in October that retail investors’ share of options trading has increased to 25% from about 20% last year.

The private markets, by contrast, sit at the other end of the regulatory spectrum. The rules that have kept most investors out of private investments for almost 90 years are showing their age, especially in venture capital. Many high-net-worth individuals, smaller family offices and endowments remain “unventured.” They may be legally able to invest in VC but they struggle to find quality opportunities, such as diversified exposure to top-quartile managers. 

Once companies go public, performance can still leave a bitter taste. Even at the end of last December, before the current selloff in public equities, shares in two-thirds of 2021’s initial public offerings were trading below their offering price, according to The Wall Street Journal. One example is Robinhood. After a long slide from its IPO spike in August, the financial services firm ended the year around 53% below its debut price of $38. Private market investors had access to a totally different experience: Entering Robinhood about a year before the IPO and exiting at the IPO price would have generated annualized returns of more than 300%.

To be sure, decades ago it made more sense to wall off investors from venture investing. Back then, data on private companies was scarce, of low quality and largely controlled by VC firms. The classic VC playbook used this information advantage to find a few portfolio home runs that compensated for mostly strikeouts. 

New playbook. But in recent years, the venture capital market has exploded in size and activity. In 2021, total deal value reached an all-time high of approximately $416.9 billion in a record 23,100 transactions, according to Pitchbook. That growth was accompanied by a lesser-known but even more important change: The quantity, quality and availability of data on venture-backed companies has reached critical mass, since traditional VC firms no longer have exclusive access to company information. Data-driven investment selection has become a reality. Furthermore, new, systematic managers have thrown out the old VC playbook and in its place, to extend the baseball metaphor, have built data-powered “Moneyball” strategies that aim for more singles, doubles, and triples, with less overall risk.  

If you still think of the entire VC market as one of “start-ups,” a term that covers the early stages of venture investing, it’s tough to understand what is coming for investors. Data on these companies remain sparse and identifying future winners takes as much art as science. Don’t be surprised if the traditional VC playbook continues to dominate here. 

But the late-stage segment is a very different story, one that is beginning to function more like a transparent public market than an opaque, illiquid one. Companies enter this market during their growth phase with Series B funding, and subsequent rounds can reach eye-popping valuations. From 2002 to 2019, managers who focused on the late-stage market had a performance advantage. Based on my firm’s analysis of Pitchbook data, the mean net internal rate of return for that period was 17.7% for late-stage U.S. managers versus 15.5% for early-stage.

In our opinion, volatility in the public markets and interest rates are certain to rise, which means even more clients are likely to ask about alternatives and private markets this year. A good place to start any conversation about venture capital is with important distinctions that impact the risk/reward equation. It’s a tale of two different VC markets, early versus late-stage, and how a data revolution is changing options for investors.

Ziad Makkawi is the founder and CEO of Equiam, a venture capital firm that has pioneered a quantitative approach to constructing risk-managed portfolios of growth and late-stage private technology companies. Makkawi has more than 30 years’ experience as an investor, CEO and CIO in private equity, debt, and equity capital markets. His career has included roles as founder and CEO of Algebra Capital, CEO of private equity firm Istithmar World, and CEO of Dubai Bank.