By: Nate Bek & Sean Sternbach
For tech workers, being an early-stage startup investor holds a distinct allure.
It’s like having a backstage pass to the pitch decks and demos that could become the next Uber, SpaceX, or OpenAI. But accessing venture capital (VC) as an asset class can seem daunting and complex — especially if you are balancing the demands of a full-time job.
Let’s break down the process.
Investors in VC funds, known as limited partners (LPs), are like the silent backers in the wings. They provide the necessary capital with limited liability, remaining largely uninvolved in the daily operations. Most LPs do not participate in scouting or decision-making, though there are a few exceptions.
Prior to recent changes, becoming a solo LP required substantial financial means. You needed an annual income of more than $200,000, or $300,000 with a spouse, or a net worth over $1 million, excluding your home.
Recent US law changes have broadened participation. The Equal Opportunity for All Investors Act of 2023, passed by the House, lets individuals qualify as accredited investors based on financial knowledge, not just income or net worth. SEC amendments in 2020 had already included certain professional certifications.
Now, passing a FINRA exam may also qualify you.
For finance or STEM workers, these changes are major. Their expertise in tech and investment means they may meet the new criteria. This opens the door to invest in startups and private offerings previously out of reach.
We want to break down the asset class for these folks. Ascend teamed up with Cloud Capital and talked to more than a dozen LPs, legal experts, and VCs.
We combined these convos with our own insights to share a detailed FAQ.
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The main draw is, of course, the potential for financial return. VC offers investors the chance to earn significant multiples on their principal investment throughout a typical 10-year fund cycle. A good fund might 10X your money.
Indeed, it’s not just about the cash. VC investing also supports broader economic growth. It’s all about placing bets on the future, funding visionary founders setting out to disrupt industries from healthcare to clean energy.
There’s also more to being an LP than financial rewards and innovation, especially in a smaller fund or angel network. Additional benefits might include:
Board participation: Some LPs have the chance to serve on the boards of companies within the portfolio. This role comes with governance responsibilities, strategic input, and sometimes additional equity stakes.
Insider knowledge: LPs get insights into the strategies and performance of startups within the fund. They use this information to offer targeted advice based on their expertise.
Networking opportunities: Regular interactions with fund managers and other LPs can open up further valuable investment opportunities and insights.
It’s worth highlighting these additional reasons to consider an investment in VC and — within each reason — you should consider the following questions:
Diversification to your financial structure
Does the inclusion of alternatives improve the risk/return characteristics of a portfolio?
Is there low correlation with public markets, or is it just an illusion of data?
Are suitable vehicles available to implement a diversified alternatives portfolio over time, industry, asset type and managers?
Performance
Do alternatives outperform public markets?
How about after fees and taxes?
Do prior winners repeat or persist? Can we use a track record to pick winners?
Investor Purpose
Are venture-based impact investments useful for advancing social objectives?
Are alternatives effective assets for wealth transfer?
Business Value
Are alternatives the best way to “beat the market” for returns-focused clients?
Will alternatives help you move upmarket, or will “demystifying alternatives” be an equally effective tool set?
Do alternatives offer sufficient confidence and value to justify the operational complexity of delivery?
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These days, most of the value creation gets done in the private markets. Before, it was mainly captured post-IPO.
For instance, Amazon’s valuation in 1997 at IPO had a market cap under $1 billion. Microsoft’s market cap was also under $1 billion in 1986, when it went public.
Today, all the larger tech companies of the decade accrue 100% of the first $20 billion in market cap pre-IPO in the privates. This means that if the right VC funds can pick great startups, there is significant upside potential before the company even goes public.
There’s been a rush into VC chasing these high returns. Here are the numbers:
$30 trillion. That’s the amount of wealth that’ll transfer to millennials and GenX over the next several decades. This cohort of investors favor investments in private technology, evidenced by growth of platforms such as AngelList ($16 billion AUM).
12%. That’s the average amount of allocation family offices put towards VC.
90%. Almost universally, family offices have exposure to private equity, investing through both funds and direct transactions. VC continues to be top of mind, with up to 90% of family offices globally reporting VC investments.
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Let’s look at VC fund performance compared to public markets.
We evaluate this through a ratio called “Public Market Equivalent (PME).” This metric compares the cumulative return of a private equity investment (net of fees) to an investment in a public benchmark. A PME of 1.21 implies that, at the end of the fund’s life, investors ended up with 21% more than if they had invested in public markets.
Click here to view the infographic.
This infographic shows us that VC fund performance has outperformed each of the indices above over the time period in question. While this data is not recent, it does highlight the impact VC calls have on a portfolio.
That said, one should still consider the following factors:
Risk adjustment: In general, early-stage VC tends to invest in very small companies with fat-tailed outcomes. There are a large number of failures and a few big winners.
After tax: How would results compare after tax to a public market fund?
After-estate tax: In certain cases, a public market fund may never realize gains, and it can pass through a client’s estate without tax. VC funds will likely realize gains, even if QSBS is present.
Additional fees: Will additional fees be applied from investment vehicles such as fund of funds to enable more confident diversified investing?
Liquidity: Venture funds often have long lockup periods, and it can take 10 years or more to fully realize return on capital.
Source: Harris, Jenkinson, and Kaplan, "Private equity performance: What do we know?" (2014). As displayed in the above graphic, PME ratios use a reference index as a public benchmark. Reference indices include the S&P 500 Index, Russell 3000 Index, and Russell 2000 Index. It is not possible to invest directly in an index. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not indicative of future results. Indices are shown for informational and comparison purposes only – there are no private equity holdings in any of the indices shown.
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The first hurdle to clear is knowing your status as an investor, whether that’s meeting income thresholds or having financial sophistication. VC is among the riskiest asset classes, so the SEC wants to know that you can recover if funds are lost.
Tier I, accredited: You’re an accredited investor if your annual earnings exceed $200,000, or $300,000 together with your spouse, for the past two years. Another way is if your net worth is more than $1 million, excluding your primary residence. Certain financial certifications can also qualify you (more on that above). Either way, this status lets you invest in VC funds that limit their investors to 99.
*Funds that take checks from accredited investors are typically seed-stage and in the sub-$100 million range. These requirements might mean an entry price between $250,000 to $1 million for their main funds, and they might even take less for sidecar funds.
Tier II, qualified purchasers: This category is for those with more than $5 million set aside for investments. Funds for qualified purchasers can accept up to 2,000 investors. These funds cater to a wealthier investor base and aren’t open to accredited investors that don’t reach the financial threshold.
*Late-stage funds, which are much larger, will require larger check sizes to reach their fundraising goals. These VC funds usually stick to this financial criteria, but they might bend the rules for portfolio founders, close friends, and top execs.
Here’s what else you should know:
LP selection: VC funds can be nit-picky about their LPs. They often prefer those with strong reputations and a clean public image, as each investor impacts the fund’s branding and appeal.
Professional background: Funds might favor LPs with a technical background or startup experience. This can help with board seats, advisory roles, or introductions.
Tech: Both big and small tech companies are generally agnostic about their employees investing in VC, as long as these investments don’t compete with the company’s interests. This is particularly true for blind funds, where LPs don’t participate in investment decisions.
Financial sector: If you work in finance, your company might have stricter rules to avoid conflicts of interest, especially with investments that could overlap with company operations or client interests.
Publicly-traded companies: These companies have specific ethics codes about investing, as well as a compliance department.
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Build your network: Access to top funds will start with who you know. Connect with VC fund managers on LinkedIn, individuals with “Limited Partner” in their bio, as well as founders who have fundraising experience. Warm intros from portfolio founders or fellow LPs can be a valuable first step into getting in front of the right fund managers.
Time it right: Understand when funds are looking for investors. Keep in touch with fund managers and watch market trends to know when to make your move. Most funds will kick off the fundraising process before they are fully deployed in their previous fund. For top VC funds, it’s like catching a train — you need to be at the station at the right time.
Match investment sizes: Know what funds expect in terms of investment amounts. Make sure you can meet these figures and have enough cash on hand in the future to be able to meet commitments when fund managers call capital (more on that below).
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Finding the right fund manager is the most important decision you’ll make as an LP. The fund manager’s execution influences the outcome of your investments.
Performance history: Review the manager’s historical performance, including returns generated, success rates of past investments, and the growth trajectories of companies they've supported. Key documents to request are Limited Partnership Agreements (LPAs), Schedules of Investments (SOIs), and recent investor updates.
Portfolio data: Examine the portfolio for successful exits via IPOs or acquisitions, and track startups that have secured significant funding in subsequent rounds. Metrics such as Multiple on Invested Capital (MOIC), Total Value to Paid-In (TVPI), and Internal Rate of Return (IRR) are essential for assessing a portfolio's success rate.
Fund duration: Remember that VC funds typically operate over a 10-year cycle. Newer funds may lack historical data, which can be used for assessing long-term performance and market adaptability.
Philosophical match: The VC fund’s investment thesis should resonate with your personal values, whether that’s driving social change, focusing on specific geographies, or empowering underrepresented groups.
Sector- and stage-focus: Match the fund’s specialized industry focus or stage of business development—from startups to growth-stage companies—with your areas of interest and perceived opportunities.
Operational competence: Assess the manager’s ability to effectively oversee the fund’s operations, from capital allocation to risk management and exit strategies.
Process: Understand the fund’s process for deal sourcing, due diligence, and investment decision-making. Ask the fund manager to explain how they can access proprietary deal flow and receive allocation in competitive deals. The best funds have robust funnels to maximize visibility and move on investment decisions quickly.
As an example, some funds implement a shotgun-like spray-and-pray model, where they invest in dozens of companies within the same fund. Other fund managers shoot from a sniper rifle, identifying very specific companies from deep due diligence and then write larger checks within each company they select. Understanding these types of nuances may sway you from opting-in, or out, of a fund.
Team: Consider the breadth of the management team’s expertise and the resources they have at their disposal for portfolio support. A strong platform team can significantly support founders and maximize the outcomes of investments by offering strategic guidance, customer leads, operational support, access to upstream investors, and more.
Research: As a starting point, ask the VC if you can talk to a portfolio company CEO and an LP in the fund. Ensure the VC is supporting founders how they prescribed in their fund offering and ensure that LPs are receiving regular communication about the fund as promised.
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Middle and lower quartile funds often do not justify the risk and illiquidity profile of VC.
Click here to view the infographic.
With close to 4,000 US VC funds, it is difficult to keep track of all fund opportunities.
Evaluating fund manager strategies is time consuming and requires domain expertise that involves detailed track record assessment, team dynamics, competitive positioning, portfolio construction, reference calling, etc.
VC remains an insular category and access requires deep-seated relationships, brand and reputation, and large minimum commitments
VC funds from 2001 to 2020, which were top quartile in their prior fund, only have a 30% chance of being top quartile, or 54% chance of being above the median, in the next fund.
Click here to view the infographic.
Source: Harris, Robert S., Tim Jenkinson, Steven N. Kaplan, and Rüdiger Stucke, "Has persistence persisted in private equity? Evidence from buyout and venture capital funds" (2022). PME ratios use the S&P 500 Index as a public benchmark. It is not possible to invest directly in an index. Index performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not indicative of future results. Indices are used for informational and comparison purposes only. 1. Top quartile funds are determined using PME data available at the time of fundraise for the next fund.
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Time management: Investing in a VC fund is passive. You provide the money, and the fund managers handle the rest. It requires little of your time. Angel investing is active. You have to find startups, do the research, and make the investment decisions. It demands a lot of your time and involvement.
Deal flow: VC funds have access to a steady stream of deals. Fund managers use their networks and resources to find the best startups. As an angel investor, you must find your own deals. You need to network, attend events, and stay active in the startup community to discover opportunities.
Portfolio risks: VC funds diversify your investment across many startups, spreading the risk. Angel investing typically involves fewer startups, resulting in higher risk since your investments are more concentrated, though you reap more upside on the winners.
Management fees: VC funds charge management fees. You pay a percentage of your investment, usually 3%, for the fund managers’ services. Also, they take a percentage of the profit called carried interest. As an angel investor, you don’t pay management fees. However, you bear the cost of your time and resources to manage your investments.
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Direct early-stage deals
Co-investments
Emerging Managers
Established Managers
Growth Funds
Fund of Funds
Starting with the top of the list above and working its way down, you will generally see it flow from higher to lower risk profiles and also higher to lower return profiles.
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If the topics above have not yet scared you away from this asset class, there are plenty of good reasons to consider venture capital as part of your overall portfolio.
Capital constraints over the past two years have created more operating discipline at startups.
VC’s have been valuing the quality of revenue over growth at all costs.
Investing is moving from “shotgun weddings” between investors and founders to traditional lengthier diligence processes for investment decisions.
With numerous layoffs from big tech firms, more and more talent is going the path of launching startups.
One of the biggest reasons is that valuations across fundraising stages have come way down since mid-2022. Take a look at the valuation data from Carta between Q2 2022 and Q1 2023:
Click here to view the infographic
Valuations have come down across the later stage. Couple favorable valuations with new tech advancements in AI and machine learning over the past 12-18 months and there becomes opportunity for venture capital funds to perform well.
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That’s a personal choice. It’s based on your financial health and how much risk you can handle. Many experienced investors advise beginning modestly. For example, starting with about 5% of your net worth is typical as you get familiar with the field. As one investor put it, it’s better not to put all your eggs in one basket. Investing in a fund can spread out your risk. It gives you a diverse mix of startups to invest in, which lowers the risk and eases the management load compared to direct angel or stock investments.
Just like a diversified stock portfolio, it is important to stay diversified in other asset classes. So, once you have identified the right asset allocation to VC, it is important to spread the risk across at least two to three venture funds. You may seek to diversify across investment thesis, geographies, funding stages, etc.
If you are allocating 5% of your net worth to this asset class, and the minimum subscription amount to a venture fund is $250,000, your net worth should be a minimum of $5 million. However, as the paragraph above stated, you may be better off investing in two or three VC funds. If each fund has a $250,000 minimum subscription and you commit to two of them, you may need a higher net worth if you are seeking to stay within that 5% threshold.
One thing that is sometimes overlooked is the capital call management side. When you commit to a VC fund, your full fund commitment is rarely called up front. Generally, your first capital call may be in the 15-30% of your commitment with the majority of your remaining commitments to be made over the next 2-3 years. Therefore, it’s important to keep liquid assets nearby for whenever future capital calls are made. It’s always a good idea to ask about the capital call schedule of each venture fund before making a commitment.
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If you have not made privately-held investments before, you may not have received a K-1. The Schedule K-1 is the form that reports the amounts passed to each party with an interest in an entity, like a business partnership or an S corporation. This tax form is part of your overall tax return each year and some funds may not provide you with a K-1 before April 15, requiring you to file a tax extension. Ask the fund about the timing of K-1s.
Not all funds are created equal. Some funds have higher fee structures than others, some funds are composed of new fund managers, have varying strategies, and a whole lot more. Spend the time talking to the fund managers and other LPs before you make a commitment.
About the authors:
Nate Bek is an associate at Ascend, where he screens new deal opportunities, conducts due diligence, and publishes research. Prior to that he was a startups and venture capital reporter at GeekWire.
Sean Sternbach is the Chief Investment Officer at Cloud Capital, a boutique RIA and multi-family office, where he analyzes fund offerings across asset classes on behalf of the firm’s clients.
Disclaimer: The information provided here is for educational and informational purposes only. It does not constitute financial advice, and you should always consult with a qualified financial professional before making any investment decisions. Past performance is not indicative of future results.