Navigating the Risks: Investing in VC Funds vs. Acquiring Companies

Investing in Venture Capital Funds vs. Buying Companies: A Risky Game of Chance

Earlier this year, a cashed-up serial entrepreneur contemplated a change of strategy that involved putting some of his money into Venture Capital (VC) funds. After a conversation with an M&A team, he was left wondering about the success rate of such a strategy in the current climate.

The reality is that investing in VC funds is a high-risk, high-reward game. Most VC funds do not reliably outperform the average stock, with over half of global VC funds producing negative returns. The power law of the VC industry dictates that only a handful of VCs generate significant returns, while the majority struggle to break even.

A recent report from Morgan Stanley analysts revealed that VC investments are a risky bet, with only a small percentage of investments generating substantial returns. The creation of unicorns, startups valued at over $1 billion, has slowed down significantly, making it even harder to pick a winning VC fund.

VC valuations are also a cause for concern, with common shares in unicorns being overvalued by 55%. This further adds to the risk of investing in VC funds.

In comparison, buying companies presents a different set of risks and rewards. While acquisitions come with their own set of challenges, such as integration risks and overvaluation, they offer more predictable returns based on the acquired company’s cash flows and synergies.

Investors in VC funds face illiquidity, with capital committed for the fund’s duration, while acquisitions can offer more liquidity depending on the structure of the deal.

Ultimately, the decision between investing in VC funds and buying companies comes down to individual risk tolerance, investment horizon, and desired level of control. While VC funds offer the potential for high returns, they also come with high risks and limited control. Buying companies may provide more predictability and control but also require a different skill set and mindset.

In the case of the entrepreneur mentioned earlier, it was suggested that his analytical and detail-oriented mindset may be better suited to buying companies rather than betting on VC funds. Each strategy has its own set of pros and cons, and investors must carefully weigh their options before making a decision.

In the unpredictable world of investments, one thing is certain – both VC funds and acquisitions come with their own set of risks and rewards, and success ultimately depends on making informed decisions and being prepared for the unexpected.