A Case for Exponential Venture Capital
The investment landscape over the past few years is characterized by all-time low interest rates, expensive stock valuations, increasing inflation risk, as well as policy and political uncertainty. Given a late-cycle environment for the American economy and equity markets, the outlook for traditional assets including stocks and bonds is lower return and higher risk in years to come. As a result, investors are seeking new investment opportunities outside of traditional assets to improve both the risk and return profiles of their portfolios.
Before joining Fuel Venture Capital, and in my position as Portfolio Manager at a boutique investment management firm that specialized in alternative asset classes, I spent years honing the investment tools essential for accredited investors to operate in non-correlated markets. Providing high net worth individuals exclusive access to extraordinary opportunities within this asset class is a critical part of an overall investment discipline — and the overall goal of serving proficiently and effectively our limited partners’ investment needs.
Many Registered Investment Advisors (RIAs) and family offices with whom I have worked allocated at least 5 to 20% of their portfolios to alternative investments — and the demand is rising. In the universe of alternative investment vehicles, venture capital, which focuses on early-stage to growth-stage companies, is growing steadily in popularity. Institutional investors, including pension and endowment funds, were some of the first to recognize the ability of venture capital to provide meaningful accretion to any asset allocation. Most endowments have committed a minimum of 5% to venture capital and Yale University’s endowment, the most long-standing and successful, is increasing its allocation in venture capital in 2018 to greater than 17%.
Not just for institutional investors, venture capital, which adds value from both the return and risk perspectives, deserves to have a place in a diversified portfolio for the individual investor.
Looking at the top quartile of managers across any time horizon, venture capital has historically generated outsized returns and has significantly outperformed all other asset classes. The outstanding returns of venture capital are attributed to the ability to identify and invest in the most innovative companies and profit from a successful exit event. In addition, private ownership enables a long-term strategic focus as opposed to the public market focus on short-term factors, thus allowing venture capital firms to have the potential to generate significant return on investment.
Startup companies are the underlying investment in venture capital, which makes this asset class inherently risky but also largely unaffected by public market volatility, changes in government policy, or fluctuation in economic data, thus enhancing venture capital’s diversification potential. In fact, venture capital exhibits historically low to moderate correlation with traditional asset classes. In other words, during times of market distress and while stocks and bonds underperform, a small venture capital allocation is designed to mitigate the risk level of the overall portfolio.
Fuel Venture Capital’s Investment Focus
Fuel Venture Capital was founded on the belief that we are living in a world of tech-driven abundance, with more and more ideas and companies that are leveraging innovative technology to achieve exponential and transformative growth. Accredited investors, financial advisors and family offices should have access to those exponential opportunities as a way to add significant alpha to their portfolios instead of only achieving average returns. There are a few factors that we have carefully considered in creating the Fuel Venture Capital Fund 2.0, so we may seek out and deliver high-quality returns for our Limited Partners.
Size: Empirical evidence shows that venture capital does not scale effectively — smaller funds have outperformed larger funds. With that in mind, Fuel Venture Capital funds are structured to maintain this efficiency, targeting LP Capital maximums at $200MM.
Stage: Investing in late-stage funds often involves less risk than in early-stage funds, since most underlying companies in the late-stage funds are already in operation and generate revenue. However, early stage funds outperformed later stage funds by a wide margin, thanks to the ability to invest early and to experience higher valuation multiple increases. As a result, Fuel Venture Capital investments target an equal balance of early-stage and later-stage opportunities to achieve a more balanced risk-return tradeoff.
Geographic focus: Our research data, which analyzes all the early-stage venture capital deals, including seed rounds, Series A, Series B, and Series C, show that the average valuation of companies in California (mainly in Silicon Valley) and in New York State that sought venture financing in 2017 are much higher than those of companies in other states. Therefore, Fuel Venture Capital looks to invest in exponential companies east of California and south of New York, extending into the Americas, Europe and Israel.
Liquidity: Fuel Venture Capital is focused on exits, not on building lifestyle companies. When there are liquidity events inside the portfolio, we distribute the returns to our Limited Partners instead of reinvesting for the term of the partnership. We have also created a Special Purpose Vehicle structure for our partner-registered investment advisor firms, allowing for liquidity for partner firm cohorts and the ability to distribute as part of a discretionary investment program.
How We Differentiate Ourselves
What really differentiates our fund from other venture capital funds is our global ecosystem. Our strategic partnership with Rokk3r, a global venture builder, allows Fuel Venture Capital to build differentiating factors that add tremendous value to our investors by achieving the upside potential and limiting the downside risks.
High-value sourcing network: Fuel Venture Capital has a stable stream of deal flow and abundant access to vetted companies, ideas, and talent across the world, thanks to our network of partnerships with best-in-class company builders, as well as our strong general partners’ relationships with many leading academic institutions.
Risk-mitigation Process: Understanding the unique and inherent risk nature of startup investing, Fuel Venture Capital applies a heavy risk-mitigation process by investing in phases along the life cycle of a company. Leveraging the partnership with venture builder Rokk3r, our investment team is able to monitor the startup companies throughout their life cycle and participate at strategic points when critical risk levels are mitigated. Our primary goal is to invest as early as our risk mitigation process allows, in companies that are engaged with Rokk3r, and founders who have validated company building experience. However, for some nascent companies that may have an interesting exponential potential but no market validation, or which are led by founders with little to no prior experiences, we want to reduce risk by investing at a later stage after they have met key performance indicators (KPI) established by our investment team. It takes more for a startup company to succeed than just a great idea, and the future success often lies in the details of execution.
A tested and proven investment methodology: Our investment team follows a rigorous screening and extensive due diligence process to identify exceptional entrepreneurs and high-potential companies that match our thesis around exponentiality (www.exponentialorgs.com). A company that emerges from the Rokk3r platform and is then selected by Fuel Venture Capital investment team has to go through not one, but multiple levels of due diligence and risk-management screens. Close association with Rokk3r’s proven company building process means a laser focus on the investment curation to create long-term value within our portfolio companies and thus increase investment returns. Our proprietary investment methodology has been applied to our Vintage Portfolio, which generated a multiple on invested capital of 6.4x, proof sourcing our thesis. At the company level, the success of Hyp3r, one of our premier portfolio companies, supports the impact our investment methodology has on early stage exponential investing.
Hyp3r developed a social media engagement platform to help businesses identify and engage influential clients at specific locations, on a personal level, and in real time. This platform was selected to join the Disney Accelerator program and won the NFL’s and TechCrunch’s “1st & Future” competition. The company has been working with corporates such as Disney, Marriott Worldwide, Burger King, Taco Bell, 24 Hour Fitness and major NFL stadiums in the United States.
Hyp3r was developed and curated within the Rokk3r company building platform and received “fuel” from Fuel Venture Capital at an advantageous time to grow. Our investment in Hyp3r continues to add value to the portfolio and the company recently was recognized as one of Fast Company’s Top 10 “Most Innovative Companies” in social media sector, with Instagram ranking № 1.
Our Fuel Venture Capital team will continue to follow our plan, process and discipline to source and invest in high-potential exponential organizations, while enforcing our risk-mitigation process. We are confident this commentary supports the advantage of a well-diversified portfolio and demonstrates the value of our fund to any venture capital investing strategy.
This post was authored by Fuel Venture Capital General Partner and Chief Investment Officer Maggie Vo, CFA. Maggie manages investment activities, leads due diligence for prospective investments, and performs valuation analysis for existing portfolio companies. To reach Maggie, email her at maggie@fuelventurecapital.com. Follow Fuel Venture Capital on social media, via Instagram, Twitter and LinkedIn.
