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- Venture is a high-risk/high-reward asset class with returns uncorrelated to returns from other asset classes.
- The return potential for venture is among the highest of all asset classes.
- Due to the high-risk/high-reward nature of venture, many VCs invest with the understanding that a majority of their investments will fail. For this reason, they often aim to have a highly diversified portfolio of venture investments to increase their odds of making a winning investment.
- Alternatively, some VCs will invest in only a handful of deals—or even a single deal—if they have conviction that it’s a winning investment.
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Suppose you had $10k to invest in late 2010.
You invested half in Microsoft, a public company trading at about $25 per share. Your $5k got you about 200 shares.
You invested the other half in an early stage startup called UberCab, which was valued at $5.5M at the time. Your $5k bought you well over 500k shares.
Fast-forward a decade, and Microsoft’s stock is now trading above $280 per share (at the time of writing). Your $5k investment grew to $56k—an 11x return. Well done!
And your UberCab investment? That company went public in 2019 as “Uber” and is now trading above $40 per share. Your $5k investment grew to $20M—a 4,000x return.
Uber offers a simplified and extreme example of the difference between investing in venture capital and other asset classes like publicly traded securities. Stratospheric returns like that—though exceptionally rare—are usually possible only in venture investing.
According to one study, just 1% of seed-stage startups funded from 2008 to 2010 (the year Uber was funded) went on to become $1B companies. The vast majority—nearly 7 out of 10—ended up dead or self-sustaining (which doesn’t typically produce big returns for venture capitalists). A Harvard University study of 2k venture-funded startups from 2004 to 2010 made a similar conclusion, finding that 75% of deals failed to produce any returns at all to investors.
While more unicorns are being produced now than ever before, they are still incredibly rare. A recent AngelList analysis of more than 2.6k deals from 2013 to 2019 found that about 2.5% of companies reached a $1B valuation.
At the same time, it takes only a couple of those big winners (e.g., Uber) for VCs to generate significant returns—so the bigger the risk, the bigger the reward. The reason is that venture investing follows a power law curve, meaning a small percentage of deals account for a large percentage of returns.
The top five companies by market cap in the S&P 500—the so-called “Big Five”—all started as venture-backed startups: Facebook, Amazon, Apple, Microsoft, and Google. Anyone who invested in these companies pre-IPO almost certainly saw outsized returns assuming they held onto their shares.
Still, venture investing isn’t for everyone. Venture investment operates on long time horizons and requires a different approach than other asset classes. Venture investors must be comfortable waiting years to see a return—if any at all—and navigate a different regulatory environment. Before investing, it’s essential to consider all your options.
In this guide, we’ll provide an overview of venture, publicly traded stocks, and real estate so you can understand the key similarities and differences between these asset classes.
Venture Capital
Venture capitalists (VCs) invest in private companies in the hopes of seeing sizable returns down the road if the company is acquired or goes public.
Venture is among the riskiest of any major asset class—since a significant portion of these investments produce no returns at all. As the Uber example demonstrates, it also carries the biggest rewards.
To invest in privately-held companies, you generally have to be an accredited investor, which means you meet certain annual income, net worth, or licensure requirements.
Venture investments usually get structured as debt or equity investments. A debt investment is a loan to the company that converts to equity upon a predetermined event, such as a priced financing round or acquisition. With an equity investment, an investor receives a certain amount of shares in the company at an agreed upon per-share price in exchange for capital.
VCs make these investments through a venture fund (a pool of capital raised from a group of investors to make a series of investments into privately-held companies) or special purpose vehicle (a pool of capital raised from a group of investors to invest in a single company).
In exchange for the funding, VCs get shares of a company that will generate returns they can sell later during a “liquidity event”—which could be an acquisition by another company or an IPO.
To be successful, VCs often rely on tech industry expertise and their ability to evaluate founders and markets very early in the process—often before the company has a product at all. A VC must learn about the company, including its leadership, business model, product, and market.
To increase their chances of getting one of those rare hits, VCs often aim to have a diversified portfolio of venture investments, especially when investing at the earliest stages.
Another key difference is the time horizon of venture investments. Once they invest, VCs must prepare for their money to be tied up for an extended period. It might take an investor 4 to 10 years to receive a distribution from a venture investment (if they receive one at all).
Compared to other asset classes, VCs also confront much more ambiguity. Valuations of companies can be extremely fluid at the earliest stages, and VCs may not know the true value of their holdings for many years in the future.
Stocks
The stock market deals in shares of publicly traded companies. To invest in the stock market, all you need is a brokerage account and some capital.
Like venture, investors in the stock market often aim to have diversified portfolios to increase their chances of finding sound investments while mitigating risk. The risk level of investing in stocks depends on the specific stock in which you invest. Investing in a small company is often riskier than investing in a large, established company.
When performing due diligence on a stock, investors often consider the company’s market cap, revenue trends, competitors, and changes in the value of the stock over time, among other factors. Unlike venture, most investors in the stock market don’t get direct access to the company’s management team to aid in their evaluation process.
Stocks are vehicles used to track and trade ownership in a company. Stock investments are more liquid than venture investments because a stockholder can sell their stock at any time. Depending on the investment strategy, stocks can be short-term or long-term investments.
Because stocks are publicly traded, anyone can track their value in real time.
Note that there’s no correlation between venture and public markets. Venture as an asset class can be performing well, even as the stock market goes down (and vice versa).
Real Estate
Real estate returns vary depending on the type of property. Average annual returns for long-term investments in residential properties in the U.S. currently sit at 10.6%. For commercial real estate, it’s 9.5%.
Real estate often requires a significant upfront investment. Like venture, these investments can be structured as debt or equity investments. With debt, the property can act as collateral for the debt issuer (i.e., a mortgage). With an equity investment, the investor buys a stake in the property proportional to their invested amount. Note that many real estate investments involve a combination of debt and equity. This is far rarer in VC.
Some investors choose to invest in one property at a time. Others may invest in a REIT (real estate investment trust). REITs are companies that own, operate, and finance income-producing properties. Investors can purchase shares in a REIT and earn returns from the profits produced by the real estate asset.
There are also private equity real estate firms that pool money from investors to buy properties. Similar to venture, investors in these private equity firms have to be accredited.
When performing due diligence on a property, a real estate investor will consider property value trends, population and job growth in the area, financing options, zoning requirements, costs of repair, rent estimates, and a host of other factors that influence the viability of a real estate investment.
Real estate valuations can change due to new demand in the market, improvements to the property, changes in the local economy, comparable sales in the area, fluctuations in interest rates, improvements in access to transportation, and a host of other factors.
Investors sometimes mistakenly consider real estate to be a “safe” investment because property values have historically tended to appreciate. The 2008 financial crisis serves as a reminder that real estate—like other asset classes—is subject to unpredictable events.
Venture Capital vs. Stocks vs. Real Estate
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Building a Diversified Investment Portfolio
Of course, as an investor you don’t have to settle on one asset class. You can strike a balance between high risk/high reward opportunities and more conservative investments across different asset classes, depending on your own risk tolerance.
If you have a conservative risk profile, you might allocate most of your capital to lower risk investments and put only a small portion in venture. If you’re comfortable taking on more risk, you might invest a significant amount of your capital in venture.
