The iSelect Approach for Institutional Investors
In recent years, institutional investors have recognized the advantages of increasing their investments in illiquid assets, particularly private companies. This strategy not only provides the potential for higher returns, but also helps to reduce portfolio volatility and exposure to the often unpredictable public markets. One well-known example of this approach is the Yale Endowment Model.
Typically, institutional investors tend to allocate a larger portion of their portfolio to private equity investments in mature companies or those requiring restructuring. In comparison, venture capital investments receive only half as much capital from these investors on average. This emphasis on private equity demonstrates the growing popularity of illiquid assets among institutional investors seeking to diversify their portfolios and achieve better returns.
According to a recent report by Preqin, global private equity assets under management (AUM) reached a record high of $4.7 trillion in 2021, with North America accounting for nearly 60% of the total AUM. Additionally, private equity funds raised a record $758 billion in 2021, representing a 38% increase from the previous year. These figures highlight the strong demand for private equity investments and suggest that institutional investors will continue to favor illiquid assets in the years to come.
However, numerous studies demonstrate that over time, venture capital returns exceed all other major asset classes and exhibit a much lower correlation to 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 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.
- 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 that has not been invested or sometimes even ‘called’. The combination of fees on uninvested capital and 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 the same manager in new funds – which puts on yet more fees.
- 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 the same manager in new funds – which puts 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 seek diversification of vintage years and funds indeed, 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 a 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 a very high deal flow to reduce the inherently risky profile of early-stage investing adequately.
- After securing this deal flow, one must devote significant resources (and demonstrate diverse domain knowledge) to adequately analyze this universe to choose the 2-3% that are ultimately chosen for the portfolio. Many institutions do not have the expertise and in-house team members to conduct this extensive due diligence.
- Once investments are chosen, extensive time and expertise is needed to monitor and assist earlier-stage companies with their growth correctly. High-quality, internal teams are often difficult to staff and retain over the longer term.
- While it is 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 creates a venture capital fund of funds but without the extra layer of fees. A way called – iSelect Fund.
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.