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In search of long-term investment returns – is now a good time to revisit venture capital?

As we enter 2019, many clients will be reviewing their investment portfolios. They will be reflecting on the year just passed, and considering the opportunities in the year ahead.

2018 was a tough year for public markets. Both the FTSE 100 and S&P 500 closed 2018 significantly down over the year, reversing the steady growth we’ve enjoyed since 2009. The Chicago Board Options Exchange Volatility Index (VIX) spiked towards the end of 2018, reflecting high levels of investor uncertainty in current market conditions.

The public market performance in 2018 was set against a backdrop of generally slowing economic growth rates, particularly in the Eurozone and China, a budding trade war between the US and China and the slowing of monetary stimulus. Public stocks have benefited over the last decade from the generous monetary policies and low interest rates since the financial crisis. This has allowed them to borrow cheaply to fuel growth and strengthen their balance sheets, but now as interest rates are rising this may lead to more speculation about those companies’ potential for profit.

Venture capital’s performance as an asset class has been historically uncorrelated to public markets, with periods of poor performance in public markets often coinciding with strong periods of venture capital performance.

The venture capital model relies on outstanding entrepreneurs creating companies that can deliver returns to investors. Entrepreneurs are always finding new challenges to tackle and companies to build. There are plenty of examples of great companies founded in times of uncertainty. LinkedIn, Skype and Skyscanner were all founded in 2003, and Airbnb, Farfetch, WeWork and Uber were all founded in 2008-09. Building a successful start-up is a long and tough journey, but with the right product it’s possible to achieve rapid growth in even the most challenging of macro environments.

For clients considering adding venture capital to their portfolio, EIS investment opportunities offer investors a cost-effective way of accessing a diversified portfolio of earlier stage investment opportunities, whilst also providing a range of valuable tax reliefs.

Estimated reading time: 2 min

 

Due to the potential for losses, the Financial Conduct Authority (FCA) considers this investment to be high risk.

What are the key risks?

  1. You could lose all the money you invest
    1. If the business you invest in fails, you are likely to lose 100% of the money you invested. Most start-up businesses fail.
  2. You are unlikely to be protected if something goes wrong
    1. Protection from the Financial Services Compensation Scheme (FSCS), in relation to claims against failed regulated firms, does not cover poor investment performance. Try the FSCS investment protection checker here.
    2. Protection from the Financial Ombudsman Service (FOS) does not cover poor investment performance. If you have a complaint against an FCA-regulated firm, FOS may be able to consider it. Learn more about FOS protection here.
  3. You won’t get your money back quickly
    1. Even if the business you invest in is successful, it may take several years to get your money back. You are unlikely to be able to sell your investment early.
    2. The most likely way to get your money back is if the business is bought by another business or lists its shares on an exchange such as the London Stock Exchange. These events are not common.
    3. If you are investing in a start-up business, you should not expect to get your money back through dividends. Start-up businesses rarely pay these.
  4. Don’t put all your eggs in one basket
    1. Putting all your money into a single business or type of investment for example, is risky. Spreading your money across different investments makes you less dependent on any one to do well.
    2. A good rule of thumb is not to invest more than 10% of your money in high-risk investments. https://www.fca.org.uk/investsmart/5-questions-ask-you-invest
  5. The value of your investment can be reduced
    1. The percentage of the business that you own will decrease if the business issues more shares. This could mean that the value of your investment reduces, depending on how much the business grows. Most start-up businesses issue multiple rounds of shares.
    2. These new shares could have additional rights that your shares don’t have, such as the right to receive a fixed dividend, which could further reduce your chances of getting a return on your investment.

 

If you are interested in learning more about how to protect yourself, visit the FCA’s website here.