How Regular Investors are Unlocking VC Level Returns

Finding a consistent investment strategy to consistently ‘beat the market’ is the goal of many professional and amateur investors.

The prospect of finding a unicorn is a promising way to achieve this, but it’s easier said than done. This strategy involves investing early in a private company prior to them going public, and realizing gains after the company’s increased valuation.

?We’ve all heard the stories of the huge wins of Silicon Valley Venture Capital firms, and it’s not surprising that many investors want a piece of the pie. It’s not necessarily that easy to get in, but given the right circumstances, even regular investors can capitalize on the pre-IPO market to unlock returns similar to a venture capital fund.

Issues facing traditional markets

Declining rates of return

Traditional investment markets are getting tougher for investments. Endless money printing has warped valuations, and it can be incredibly difficult for investors without inside knowledge to play the game and win.

?That’s not to mention the serious volatility we’re seeing right now, and an economic environment that doesn’t look like improving any time soon.

New risks of IPO investing

Investing in companies undertaking an initial public offering was popular for a long time. Yet past market performance is no longer guaranteed due to different conditions in the startup scene.?

For instance, modern startup founders are increasingly cashing out of their businesses after going public. This can cause a serious impact to the management and vision of the company, and significantly decrease future valuations.?

Advantages of the pre-IPO market

Venture capital investing is still obtaining some of the highest returns available. The problem is that until recently, investing in private companies before they went public was largely inaccessible to many investors.

Increase in startup funding

Despite the gloomy economic backdrop, startup funding is booming. Q2 of 2021 featured the largest amount of global startup funding ever, at a record $156 billion of financing. Venture capital firms increased funding at all stages of the startup cycle from Series A to Series D.

?More total startup funding means that more companies are obtaining the capital required to expand business operations and achieve unicorn status.

?Higher Alpha

Pre-IPOs can offer “higher returns with disproportionately lower risk”, known as excess return or alpha.?

This is mainly because many startup companies experience their highest growth and accompanying valuation increases after receiving later rounds of venture capital funding and prior to IPO.

?For example, in 2021 our clients received an average return of 158%.

How to start investing in the pre-IPO market

Pre-IPO investors represent interested buyers, but finding the sellers in this market is the real challenge. After all, the definition of a private company is that its shares aren’t widely available for purchase.

Shares of private, pre-IPO companies are often sold by employees who want to realize immediate gains. Such employees may be selling their shares for a number of reasons, and most retain substantial holdings in their company.

One of the best ways to structure this type of transaction is through the use of a Special Purpose Vehicle (SPV). This is a formal arrangement that allows an employee of a unicorn startup to release their shares into a corporate entity which is regulated by the SEC.

?Investors are then able to allocate their funds to the SPV to purchase the shares in question. This ensures that the whole process follows all the legal requirements for off-market transactions, and also creates a portal where investors can monitor their account and view their positions.

?Longer investment time horizon

Proper timing is essential to maximizing returns in pre-IPO markets. Pre-IPO investing is a longer term strategy than typical IPO investments, which often follow a momentum based strategy.?

One rule of thumb is to start investing in private companies around two years prior to IPO. Then, investors should be prepared to hold for 6 months after the IPO while waiting for the optimal time to realize gains.

Following an investing strategy

There are many investing strategies, but a common approach for identifying potential investments and timeframes is the three trigger investment strategy.

This strategy is ultimately based on following key indicators based on how larger venture capital invest their money in startups. The strategy can be broken down into three simple “triggers”

1. A leading venture capital fund invests in three or more startup funding rounds
2. The startup company completes the Series D funding round.
3. Investors then start buying secondary shares if the Series D funding round exceeds $100M

Following the money of experienced bigger players is a viable strategy that can lead to huge returns.

To learn more about these types of funds, investment strategies, or how investors can get started, contact Venley Capital.