The iSelect Approach for Family Offices and Institutional Investors
Virtually all Family Offices have built their wealth based on an underlying business that was tremendously successful. As such, the concept of investing for the long term in private companies, particularly those in a familiar industry, is logical and natural. As well, over the last few decades, institutions have increasingly understood the benefits of greater allocations to more illiquid assets (such as private companies), as a means to not only capture higher returns, but to also reduce overall portfolio volatility and exposure to frequently volatile public markets. The classic example of this strategy is the Yale Endowment Model.
Most family offices and institutions heavily weight their allocations to private companies that are relatively mature or in need of repositioning or re-engineering (private equity). In fact, in general, institutions allocate twice as much capital to private equity than venture capital, and as of 2016, 81% of family offices are investing in direct private equity deals. Again, this makes sense as families and institutions are familiar and comfortable with ongoing, cash flowing businesses that are generally seen as ‘lower risk’ that earlier stage, venture type companies.
However, numerous studies have demonstrated that over time, venture capital returns exceed all other major asset classes, and exhibit much lower correlation to a portfolio’s underlying stocks and bonds, than private equity or other major, illiquid asset classes. We outline this dynamic in our recently authored white paper on venture investing, which you can download here: iSelect Venture White Paper.
While we are clearly strong advocates for early stage venture capital investments, it is also clear that traditional investing in this asset class does pose some challenges. To cite a few:
Virtually all traditional venture funds have a 10-year investment period – thus locking up capital for at least ten years (some utilize provisions to extend this period). The actual investment period may only last for the first 5 years or so, with the remaining years dedicated to harvesting the companies. This limits the number of opportunities a fund can invest in.
Fees are charged on committed capital – capital that has not been invested or sometimes even ‘called’. The combination of fees on uninvested capital, along with the fact that these funds are not invested in a company to start with, may materially affect returns over time.
Specific fund vintage years (the year first investments are made) can expose an investor to business or investment cycle risk. One is locked into this specific 10-year period. If an investor wants to diversify their vintage years, they would need to invest every year with different managers or with the same manager in new funds – which layers on yet more fees.
High minimum investments (of at least $1 million) are usually not an issue with family offices or institutions for a one-time allocation. However, if one were to indeed seek diversification of vintage years and funds, one would need to invest $1 million every year for let’s say five years, in order to accomplish this goal. That level of commitment may be beyond the means of smaller family offices and institutions.
It is possible to act on one’s own as a direct investor in companies – an angel investor, a participant in crowdfunding platforms, or even as an investor in venture capital fund of funds. While more and more family offices and institutions are directly investing in private equity, we believe it is far more difficult to replicate this strategy in venture capital:
One must secure very high deal flow to adequately reduce the inherently risky profile of early stage investing.
After securing this deal flow, one must devote significant resources (and demonstrate diverse domain knowledge) to adequately analyze this universe in order to choose the 2-3% that are ultimately chosen for the portfolio. Few family offices or institutions have the expertise and in-house team members to conduct this level of extensive due diligence.
Once investments are chosen, extensive time and expertise is needed to properly monitor and assist earlier stage companies with their growth. Often times, high quality, internal teams are difficult to staff and retain over the longer term.
While it is clearly possible to generate higher returns by investing as outlined above, we believe there is a better way. A hybrid approach that combines the best attributes of a traditional early stage fund,
with the freedom of direct investing. A way that provides diversification exposure to companies, multiple VC funds, industries, and stages. A way that in effect, creates a venture capital fund of funds, but without the extra layer of fees. A way called – iSelect Fund.
iSelect fund provides access to a heavily vetted, diversified portfolio of early stage companies in generally uncrowded regions and sectors of the United States. And we do so in an extremely Limited Partner-friendly manner. A few advantages of our approach include:
Focus on Uncrowded Regions and Sectors
Since 2011, 75% of all venture capital investments have been directed at only three states, and 50% of all capital in only three sectors. Even if you are invested in traditional funds with this exposure profile, we believe it is prudent to also take advantage of opportunities in the other 47 states and multiple other sectors. At iSelect, we invest primarily in the U.S. Midwest, South and Mountain areas, and we focus on sectors such as Healthcare, Agriculture, Resource Efficiency and B2B Technology.
Virtually all venture capital funds conduct extensive due diligence and generally only accept 2-3% of the deals they review. This is one of the reasons Family Offices and Institutions invest through a fund, as opposed to direct investing (as outlined above, we believe it is much harder to invest directly and create a diversified portfolio of early stage companies, vs. direct investments in more mature, private equity stage companies). iSelect is similar in this respect, yet we also provide additional levels of due diligence that ensure the companies that make it on our platform, are among the most heavily vetted in the world. Each company in the iSelect portfolio is subjected to four levels of review. The first level is the extensive due diligence conducted by our partner funds. We respect their expertise and processes and know that before we even see the company, significant due diligence has already been conducted. After iSelect decides to move forward with a prospect, our Ventures team takes over and conducts our own extensive and disciplined due diligence process. In conjunction with this review, we also utilize an outside Selection Committee that’s composed of independent entrepreneurs, business executives, world renowned scientists and researchers, and accomplished venture investors in market niches including Healthcare, Agriculture, Resource Efficiency and B2B Technology. In total, iSelect and its Advisors conduct over 120 hours of our own due diligence on each company that eventually makes it into our portfolio. Only after all three levels have been successfully completed, does the decision to move to a fourth level occur – iSelect’s Investment Committee conducts a final review to invest.
Evergreen Fund – No Vintage Year Risk
iSelect is structured as an evergreen fund, not a typical 10 year limited partnership. As such, we are not limited by the usual five year investment period, followed by a five year harvesting period. New investments and follow-on rounds are generally available on our platform every month. This not only provides continuous opportunities to allocate capital, but also provides a means to automatically allocate larger capital commitments over time. This has the added benefit of largely shielding family offices and institutions from the impact of specific investment or business cycles. There is not one ‘vintage year’ – you can spread your investment across multiple years, multiple companies, and multiple sectors.
The Ability to Curate your Capital
For all investors, and as outlined above, we generally advocate a diversified allocation across all of our companies. However, for experienced and larger investors such as Family Offices, UHNWs and Institutions, we also enable you to focus your capital on the particular companies, sectors or regions that are of most interest to you. Perhaps there is strong interest in curing cancer, addressing global food shortages or climate change. iSelect can work with you to concentrate or perhaps over-allocate to some extent in these areas. This also further mirrors direct investing as you have much more control over where your capital is allocated.
Pro-Rata Participation Rights
These rights are typically negotiated as part of an early stage investment, giving Seed investors the opportunity to continue to invest in later rounds so that they can maintain their ownership stake as the company grows. They give an investor the option, but not the obligation, to invest additional capital in follow-on rounds of fundraising. As a result, the investor is able to effectively “double down” on the most successful companies in their portfolio without dilution in later rounds, maintaining their stakes even over the long timeline of today’s venture-backed companies. iSelect allows investors access to these participation rights in later-stage deals.
As a fund, iSelect does charge management and carry fees. However, in addition to being lower on an absolute basis than most VC funds, we also only receive management fees on invested capital vs. the typical committed capital structure. In other words, our management fees are only received upon actual capital being sent to our portfolio companies. This is markedly different than most funds who charge and receive management fees based on the capital that is invested in the fund (but not yet invested in an actual company). We believe we should be compensated for managing companies – not cash!
High Capital Utilization & Potentially Higher Returns
The ability to immediately put your funds to work via our evergreen structure can have a material effect on returns over time. By ‘being in the market’ all the time, via our continuous, monthly investment cycles, capital is put to work and is not sitting in a fund or bank account (being charged fees!). In addition, iSelect not only enables Family Offices and Institutions to invest as much or as little as they desire, but also to allocate when they desire – not when an external VC ‘calls’ the capital.
At iSelect, we truly have the Limited Partners’ interest at the forefront. We are one of the first funds in the U.S. to offer such a ‘personalized’ venture fund, and we are proud of the flexibility and opportunities this provides our current Family Offices, Institutions, and accredited investors.