Changing regulations are allowing more people to make investments in startups. More people like yourself have a shot of getting in before the IPO of the next unicorn. A unicorn company reaches a $1 billion valuation without being listed on the stock market. The return potential of investing at the first round a startup founder is raising capital can be life-changing. Imagine that your equity investment in a business you believe in takes off and shoots to a billion-dollar valuation. I certainly aspire to make this happen for my portfolio. So who is making this happen today?
The alternative asset class of Venture Capital is somewhat opaque, so finding who is the best is challenging. Nevertheless, a few FinTech firms are providing ranks based on data and multifactor weighted models, empowering co-investment. CB Insights, Preqin, and Pitchbook each rank top fund managers based on inputs like performance, fees, and follow-on investments.
What can we learn from those that have reached the pinnacle, landing several billion-dollar exits? I am new to angel investing. So I want to learn from the best.
I created Fund Wisdom around the time Title III of the JOBS Act passed because I was not accredited and wanted to be at the forefront of the industry that could emerge from the changes to access. I write about seed-stage investing and work full-time managing top customers at a software firm. The regulatory changes with SEC rules have allowed me to invest in startup equity before I became accredited. I look to uncover winning strategies from the best and those on their way to the top.
Due to differences in performance metrics and timing of cash flows, comparing the performance of money managers in different asset classes is difficult.
The methods to analyze returns across asset classes continue to evolve. Greater access to performance data makes it possible to measure angel and venture capital fund managers more objectively via algorithms.
Angel investors primarily put money in startups at the stage entrepreneurs first look for outside (e.g., friends and family) capital. This is called seed-stage funding. Angels will sometimes participate in follow-on funding rounds, such as Series A, B, or some as late as C.
Angels and venture capital often use multiples like “a return of 2x capital invested,” and private equity often uses the internal rate of return (IRR). I would prefer to see a compounded annual rate of return over an extended period. Therefore, comparing these alternative asset classes to one another becomes difficult, as does indexing against a benchmark (e.g., the S&P 500).
The timing of cash flows becomes an issue. When an individual or institution commits to a fund, the money gets invested over time (sometimes 10 to 15 years), which places more weight on the earlier cash flows. Fund Managers will invest or enter companies at differing stages in company growth. This increases the importance of reviewing a rankings view. I have seen many that look at just one-year performance.
AngelList syndicates represent a significant shift to hit the venture capital and angel investment industry. Angel investors can create their own funds with many of the same resources as a venture capital fund.
Through this structure, lead investors, or fund managers, get access to more deals and later stages. These lead investors also receive carried interest and get paid when the syndicate performs well. Startups get more capital with fewer meetings.
Syndicates offer diversification through access to a high-risk asset class while spreading risk across several startups. Investing in a single syndicate can diversify your early-stage, high-risk bets. Investors can invest as little as $1K. Leads get carried interest, major investor rights, and access to syndicate investors often experts in startups. These individuals can invest five to ten times their typical investment amount, which allows them to access and lead more deals.
CB Insights runs in-depth ranks based on several variables, such as network strength, rate of follow-on investment, performance persistence, number of exits, and more. They pull each into an algorithm to build their proprietary list of top performers.
The data is collected by 75% scraping — the use of software that parses data sources and extracts key pieces of information — the remainder comes from direct submissions and partnerships with Silicon Valley Bank and the Angel Resource Institute. In the past, they have provided the list publicly, but now you must sign up for their service.
The list is based on data collected from publicly available sources and direct submissions from the firms. Midas provides a five-year retrospective of a partner’s portfolio, including exits by IPO or acquisition of $200 million or more, as well as private holdings that raised money at valuations of $400 million or more. This includes a discount for the unrealized return.
Midas’ formula favors earlier, bigger bets that return high multiples on an investor’s initial money, though a string of later successes can still make a Midas portfolio.
Preqin offers a report with the top firms each year. The performing ranking takes into account multiple vehicles within a fund series. Preqin only assigns quartile rankings to funds with a vantage older than three years because more recent fund performance tends to be less meaningful.
Furthermore, the tables are restricted to active fund managers that raised a fund in the past six years or active managers that are currently raising a fund of a similar strategy and previously raised at least three funds of a similar strategy.
In order to identify the venture capital fund managers that are most consistent, an average quartile ranking is calculated and assigned to each fund manager. Funds are then scored based on their quartile ranking. Top quartile funds receive a score of 1.00, second quartile funds are given a score of 2.00, etc. Finally, an average is taken to calculate the tables.
Solutions like CB Insights, Preqin, and Pitchbook provide thorough and objective rankings. These fintech companies help investors like you source top managers and find the next emerging stars. Understanding their selection methods and algorithms can help you develop your investment strategy.
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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):
This is an updated version of an article originally published on April 10, 2019.]
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Brian Thopsey, founder of Fund Wisdom, writes about startup investing nights and weekends while working full-time at Adobe in the Experience Cloud business. He advises Fortune 100 financial services and healthcare firms across content strategy, marketing, and analytics. Brian has a BS in Computer Science and an MS in Finance. He spent his early career…