Traditional investment avenues such as stocks, mutual funds, gold, real estate have been long loved by High Net Worth Individuals (HNIs). However, in the last few years, with real estate losing its sheen, debt mutual funds going down and inherent volatility in the markets, investors are looking at alternate asset classes for higher returns.
Over the last few years, venture capital has attracted more interest as investors started talking about a few hundred thousands turning into millions and sometimes even billions. Holding the baton were the poster boys of the e-commerce industry who hit the headlines with astonishing valuations that rewarded the patience of angel investors. These were new, but for some, unconventional investment assets called venture capital and its returns became too big to ignore. This caught everyone’s attention, especially the rich who saw this as a new area of returns. In many cases, it satisfied the fourth step in Maslow’s Theory of Hierarchy - the self-esteem need - giving back to society by creating jobs and supporting innovative minds.
Investors have trusted mutual funds and these have become an integral part of everyone’s portfolio. On the other hand, real estate that was the preferred mode, is plagued with a lack of transparency and diversion of funds across projects. Alternative assets like angel funding, venture capital, private equity, investment trusts are blessed with the goodness of Sebi regulations, much like the mutual funds. The Alternative Investment Funds (AIF) Regulations 2012, governs pooling of capital, thereby ensuring transparency, professional management of funds and adherence to the stated investment objectives. Each AIF seeking investments has to be registered with Sebi; however, many of them are also enjoying capital contributed to their fund corpus by several sponsored programs of the Ministries of the Government of India. These venture capital funds typically have 15-35 per cent of the corpus contributed by such ministries.
The AIF regulations require an individual or entity to make a minimum capital commitment of `1 crore. This commitment is drawn over a period of two to five years from investors as and when the fund manager identifies new avenues to invest in. The cash outflow is more like a construction-linked payment plan in property investment. There is another inherent benefit of investing in AIFs. The underlying start-up investments are mandatorily held for long-duration until the full strategy for investing in them has played out. This yields an advantage of compounding, with possibilities of 15x-50x multiple on the invested capital in some start-ups. Some start-up portfolios are delivering 30 per cent+ annual return. Such returns do come with start-ups bringing new solutions. But, what about risks? Are there any? Yes, but a rigorous and disciplined approach towards start-up funding helps maximise investment returns and reduce risks. Direct investing in start-ups or unlisted companies is complicated, time-consuming and filled with the challenge of limited access to the best-in-class ventures. This is where a trusted advisor comes in. Here are some points to ensure mitigation of risks:
1 Choose the investment domain; identify the fund thesis that can create economic value
2 Who are the fund managers? Historically, top-performing fund managers have continued to identify successful businesses and teams. Remember that you are investing in people’s capabilities to identify the entrepreneurial team and visualising future
3 Diversify your portfolio; Invest across a few chosen fund managers
Let me introduce the new title when you invest in an AIF: Limited Partner (LP). We address our investors as LPs, whose liability is limited to the capital committed but the upside is uncapped. Internationally, fund managers of AIFs are called General Partners who earn management fees and get a share of capital gains provided they deliver more than the hurdle-rate of annual return.
The start-up eco-system has evolved in recent years, fueled not just by more entrepreneurs but also by exits and overall buoyancy in angel investing. Over the last decade, the funding landscape for AIFs has seen a gradual inclusion of HNIs in addition to private and government-backed financial institutions and await many more to become LPs.
The author is MD and Fund Manager at YourNest Venture Capital