Almost every day I get asked about how investing in a VC fund is different from a startup. So this is a post summarizing the core questions, in the hopes of being a practical guide for anyone considering it or doing it already.
1) Diversifying Your Assets – Investment managers will often advise you to put at least 10% of your assets into alternatives. If there is any asset where you could make 10x in a year, startup and VC are the most likely ways to go about it, albeit it’s still very hard. Once a round closes in both cases you can’t add more monies unless you buy someone else out, which is somewhat common in startups and extremely uncommon in VC.
2) Differences In Investing In A Startup Vs VC Fund – Beyond the obvious difference of a startup being a single bet while VC is a pool of companies, there are several key differences to keep in mind.
3) Time Horizon – Startups and VC are both long-term investments, think of 10 years as being typical. But there are ways in which you can get returns much earlier, the main one being a secondary You may be able to do a secondary i.e. sell your shares to another investor. For startups there is usually a discount and anywhere between 10% and 30% is standard. For a VC it’s not a common situation but funds can facilitate it. Most likely the VC will send you returns once they themselves do a secondary, or if the investment has a traditional exit through an IPO or M&A. For both startup and VC, there is an implied if not outright formalized right of first refusal, meaning the company can make the first offer to buy those shares before anyone else.
4) Collaborations – Beyond working for or investing in the startup, you can be affiliated as a mentor or advisor (often compensated with a small equity). Being an independent board member is a stronger commitment / compensation but it is often because the company seeks you given the relationship or your expertise when they are at least a series A. Some past articles exploring these topics in more depth:
i) So You Want To Invest In Startups? 5 Ways Other Than Being A Full-Time VC
ii) Beyond VC: Leveraging Other Forms Of Capital Or Being An Investor Yourself
iii) Angel Investors Matter — 4 Key Principles
iv) Startups And Independent Board Member — Best Practices
VC funds also have mentors and advisors, the latter are sometimes compensated with a small equity, typically out of the carry (the percent of profits the VCs themselves get). There is no analogue really for an independent board member but there is a role often termed venture partner which can be seen as a super advisor. EIRs come in two different flavors: entrepreneur in residence incubate a company, executive in residence hang around the firm looking for a company to join in a senior capacity.
5) The TLDR – Investing in startups vs funds are not mutually exclusive, in fact many do both. Many angels collaborate very closely with VC funds to leverage their pipeline, share their own companies, help each other in diligence. Early-stage is especially collaborative and most VC funds actively seek to coinvest, sometimes sharing with their LPs for small or no extra fees.
Our own common sense advice is to put money into startups when you are comfortable that it may not come back any time soon or at all. In fact, increasingly we see angels specializing, investing in startups when they know the space or the team very well. For VC chances are high you will get at least your money back eventually but you may now make as much as you expected. Small funds typically perform much better than large funds because it’s much easier to get outsize returns with smaller numbers, the investors themselves are presumably hungrier, and they have more flexibility to buy / sell shares. All of these are general norms that can help you evaluate each case but should never be the only deciding factor.
Originally published on “Data Driven Investor”. Amit is Managing Partner and Cofounder of Tau with 20 years in Silicon Valley across corporates, own startup, and VC funds. These are purposely short articles focused on practical insights (we call it gl;dr — good length; did read). See here for other such articles. If this article had useful insights for you, comment away and/or give a like on the article and on the Tau Ventures’ LinkedIn page, with due thanks for supporting our work. All opinions expressed here are from the author(s).
