How To Beat The Dragons To Better Venture Capital Returns

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Investors can gain better returns than TV’s dragons or most professional venture capitalists by randomly staking their money on start-ups, according to a new study.

Equity crowdfunder SyndicateRoom tracked the progress of more than 500 businesses that sought seed or growth funding in 2011 over five years.

The study also applied the same scrutiny to venture capitalists and the TV dragon investors.

The result was diversifying investments among a portfolio of start-ups outperformed the professional backers in almost every case because the way they picked their investments often overlooked companies that returned better results.

“Had you invested £10,000 in the full cohort back in 2011, by the start of this year your portfolio would have been worth £72,800. Given that the majority of the 2011 raises will have been eligible for Enterprise Investment Scheme (EIS) tax relief, the gain for qualifying investors would have been even greater,” says the SyndicateRoom report.

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50% better growth than dragon investments

“By comparison, publicly reported investments made by the dragons in 2011 and 2012 grew at an average rate of 16% up to 2019. Our data also followed the 2011 portfolios of 479 venture capitalists, which together grew at 19% compound annual growth rate (CAGR).

Indeed, based on investments made in 2011, only 38% of UK venture capitalists outperformed the start-up cohort. This means that most venture capitalists would be better off picking their investments at random, rather than trying to pick the ones they think will succeed.”

Over the five-year study, the original businesses had various fates:

  • 83 led to investor exits
  • 93 failed
  • 170 were ‘zombies’ that still traded but showed no sign of returning profits
  • 74 moved from the seed to growth stage
  • 86 entered the venture stage

The 506 companies returned an average 28% a year growth, compared to 16% for the dragons and 19% for the professional venture capitalists.

Crunching the numbers

Names in the list included TransferWise, the currency exchange app; Nutmeg, the robo financial advice firm and travel site The Culture Trip.

“After carrying out repeat simulations of various investment strategies (100,000 simulations per strategy), we found that one of the most successful was to spread your risk among as many companies as possible. We dubbed the strategy ‘radical diversification’,” says the study.

“We simulated investing into companies that raised between £500,000 and £5m in 2011 to create portfolios of varying sizes. The simulations assumed that a fixed amount was invested into a single round of each company, with no follow-on investments being made.

“On average, a portfolio of 30 investments returned 3.7x of the initial investment in total over a seven-year period; when diversifying even more dramatically into 80 companies, this figure returned 4.7x.”

Three golden start-up investment rules

The golden investment rules, says the study are:

  • Invest in more than 30 start-ups- for £150,000–£2 million fundraising rounds, a spread of 30 investments gives the best return.

For £500,000–£5 million rounds, the trend continues past 30 companies, so the more businesses you invest in, the greater the likelihood of higher returns.

Radical diversification stays true for smaller start-up rounds (£150,000–£2 million), though the rate of return slows once the portfolio reaches around 30 investments, giving a 2.3x return; while a portfolio of 80 investments averages 2.5x returns.

This strategy allows investors a much higher chance of backing massive success stories

  • Avoid selection criteria- Don’t discard companies from your investment list for any reason
  • Only invest through the best venture capital networks- The best performing 2011 portfolios were:
  1. Oxford Early Investments (90% CAGR)
  2. Cambridge Capital Group (83% CAGR)
  3. Nexus Investments (81% CAGR)
  4. White Rose Technology Seedcorn Fund (78% CAGR)
  5. Fusion IP (70% CAGR)

Stacking the odds in your favour

“The numbers seem pretty conclusive – diversify into more start-ups and achieve a higher likelihood of returns. The problem? Many rounds will have a minimum amount you must invest, so unless you have a significant amount of wealth at your disposal, the number of businesses you can feasibly back is limited,” says the study.

“And that’s before you remember that many businesses will approach angel groups and VCs first, meaning they’re the ones who get first dibs – and the lion’s share – of the equity.

“With that in mind, here are two things you can do to bolster your odds – access firms through a venture capital fund and invest in more than 30 start-ups.”

Read the full SyndicateRoom study How To Outperform VCs

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