Venture capital investment opportunities have enabled many exciting endeavors for investors. Huge winners like Facebook, Amazon and Apple are great examples. But there are also well-known disappointments. Blue Apron and Snap are two recent startups that disappointed their late-stage venture capital supporters with their IPOs.
Assessing a venture’s value is difficult, but the principles are straightforward. Value depends on the probability of marketplace success and how much money investors expect to make with that success. It also depends on how long investors expect to wait for their reward. (Remember, time is money.)
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Also remember that venture capital investment opportunities are risky. Most ventures fail. On average, only about 15-20% deliver positive returns. Those positive returns, though, can be tremendous. That’s why venture capital investments on average deliver rich returns. Returns have averaged 19.7% per year since 1996. This is based on the Thomson Reuters Venture Capital Research Index, which reflects the venture capital industry as a whole.
Venture capital investors need to recognize a venture’s levels of risk and potential reward. They must also consider how long it is likely to take to realize the potential reward. Think about your personal risk tolerance, including how long you are willing to wait for a return. Then you can decide whether to consider this asset class and, if so, the sorts of venture capital investment opportunities in which to invest.
Venture capital investors need to recognize a venture’s levels of risk and potential reward.
The graph below is a useful way of thinking about these decisions. You should only take on more risk when the potential reward justifies the risk. To win, you need to find deals where the potential reward even more than justifies the risk.
The firm at which I serve as an advisor, VCapital, works hard to assess this risk/reward tradeoff. The team leading this new online firm has had an enviable track record in predecessor firms. Over the past 30 years, 37% of its investments have been winners, double the industry average. They have delivered gross investor returns of 28% per year, much greater than industry norms.
Some of our current investments exemplify the risk/reward tradeoff. Considerable risk is okay as long as the potential rewards justify those risks.
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Here are a few examples:
One of the very risky investments at VCapital is in Intensity Therapeutics. This company is pioneering a new field of cancer treatment: in situ vaccination. The doctor injects chemotherapy directly into the tumor. Less chemo is thus needed than through traditional transfusion into the bloodstream. The chemotherapy consists of proven chemotherapy agents along with a proprietary enhancer.
The result in mice has been not only fewer side effects, but also remarkable success in shrinking tumors, sometimes eliminating them completely, along with apparent inoculation against future cancer. But mice aren’t humans. The path to FDA approval is long and risky. Intensity Therapeutics is now in Phase 1 clinical trial to establish safety in humans. Only 9-10% of drugs in Phase 1 clinical trial make it all the way to FDA approval. For oncology drugs, the probability is much lower at 5%. But the potential reward, especially for a groundbreaking oncology drug, is huge because of its potential to challenge traditional cancer treatments.
…the potential reward, especially for a groundbreaking drug, is huge.
The good news for investors is that the probability of the FDA approving Intensity Therapeutics should be better than for other oncology drugs because Intensity Therapeutics uses proven/already approved chemotherapy drugs. The bad news for interested investors is that this company is not currently available to new investors. Moreover, if it makes it through to further clinical trial phases, its valuation (i.e. its price per share) will increase dramatically.
VCapital’s investment in a venture called Synap, a software-as-a-service company in the CRM category, is a little less risky. But it’s still pretty high on the range of risks and potential rewards.
Synap delivers important innovation to the CRM category. It is easy to use with little technical support. It integrates seamlessly with existing CRM systems. Most important, it connects with the user’s email account, eliminating cumbersome manual processes in creating a complete contact and company database.
The risk is that [the innovation] may fail to break through competitive clutter in its category
So why does VCapital regard a Synap investment as risky? The risk is that it may fail to break through competitive clutter in the CRM category. It will be difficult to overcome inertia among companies already using CRM systems. We believe the potential reward is great enough to justify the competitive marketplace risk.
Our investment in Camras Vision is somewhat less risky, but still offers substantial, though less dramatic, potential reward. Camras’ mission is to tame glaucoma. Glaucoma is the leading cause of irreversible blindness. The condition affects an estimated 67 million people worldwide. Current treatments are either drugs, with a failure rate of up to 35%, or shunt implantation surgery, with complication rates of 20-40%. The reason for so many failures and complications is that neither option can predictably achieve the precise pressure in the eye required to prevent vision loss.
The risks of achieving FDA approval and insurance company reimbursement, however, are not trivial.
The Camras Shunt is the first treatment that predictably controls individualized pressure in the eye to prevent blindness. This device is also easier to implant, minimally invasive and reduces surgical time by approximately 50% compared to other shunt procedures.
The Camras Shunt is already developed and has proven efficacy in early testing. The risks of achieving FDA approval and insurance company reimbursement, however, are not trivial. The probability is greater, though, than achieving FDA approval of an oncology drug, and the time required should be far less. Despite Camras’ superiority, we expect marketplace adoption to be constrained somewhat by likely inertia among ophthalmologists.
The last investment I’ll describe is The Padcaster. It is still less risky, and has less dramatic (though we still believe very attractive and faster) reward potential.
The Padcaster is a patented, rugged iPad case that accommodates a range of value-added accessories. The integrated set-up transforms the iPad into an all-in-one mobile production studio. The Padcaster enables consumers to shoot, edit and upload video from the field and even to stream live from the iPad.
Fast, professional adoption makes [an investment] a less risky
The Padcaster began as an idea to help amateurs shoot video. It has, however, quickly become an accepted solution for businesses to shoot professional quality video. Customers already include television news stations, journalists, professional service firms, schools and filmmakers.
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This fast professional adoption makes The Padcaster a less risky investment. Marketplace appeal is clear and proven. But it still entails investment risk. The payout on marketing investment to accelerate growth is uncertain. Speed of business growth will be important due to the threat of competition emerging. Also, will consumers buy The Padcaster technology for use with smartphones, which could result in much greater growth?
In summary, no venture capital investment opportunities are risk-free or even low risk. But there are a wide range of risk levels along with a similar wide range of potential rewards. Investors need to recognize their personal risk tolerance. They should then seek investment opportunities with attractive reward potential relative to their risk tolerance.
Strategic adviser to high tech venture capital firm, VCapital, following career as CEO-level consumer products/marketing services executive. Co-author of "Building Wealth Through Venture Capital: A Practical Guide for Investors and the Entrepreneurs They Fund" published in 2017 by Wiley Publishing.
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