Why Venture Capital Funds Beats Investing In Individual Companies

If you want to invest in venture capital, I believe it’s more beneficial to invest in a venture capital fund than in individual private companies. By investing in a venture capital fund, you will not only decrease your chances of losing money but also increase your chances of earning a positive return.

I’ve been a venture capital investor since 2001, and I strongly discourage angel investing. More often than not, you will end up losing the vast majority of the time. Additionally, when you lose, you are likely to lose all of your money invested in the private company.

Over time, my conviction in avoiding investments in individual private companies has increased. The main reason is my experience as a limited partner in multiple closed-end venture capital funds.

I’ve seen the outcomes of which companies succeed and which fail. The odds are not in favor of the individual private company investor. As a private company investor, you must diversify. And the easiest way to diversify is through a venture fund.

Long Odds Of Hitting A Venture Investment Winner

As a limited partner, I recently viewed a quarterly update from a small early-stage venture capital fund. I hadn’t attended one for over a year because I prefer to be completely hands-off once I commit and submit capital. Not having to think about how my money is being invested is one of the reasons why I invest in private funds and am willing to pay their fees.

The venture capital fund invests mostly in seed rounds and some Series A rounds. These funding rounds typically occur within 1-3 years of a company’s inception, which means greater risk. However, if the companies succeed, the returns could be enormous. The founders all have impressive resumes, and the problems the companies aim to solve seem promising.

Just know that before investing in anything, the marketing material always makes an investment sound promising. But of course, not all investments work out, which is why diversification is important.

Venture Capitalists Know the Odds of Winning Are Low

During the update, I was shown a slide, which I can’t share here due to privacy concerns. It depicted a bubble chart of 60 companies the fund had invested in. One small bubble represented the 6 expected winners, a medium-sized bubble represented 30 companies that would survive with insignificant exits, and another bubble represented 24 companies forecasted not to succeed.

What amazed me was that, despite the fund managers’ willingness to invest in 60 promising companies, they already expected to lose 100% of their investment in 40% of the companies (24 out of 60), and 50% of the companies (30 out of 60) to produce little returns or lose money. Only 10% of the companies were expected to be profitable.

As an individual investor, the chance of you investing in a winning private company is far less than the 10% probability for professional venture capitalists. Additionally, the chance of you losing all your money in an individual company is far greater than the 40% probability for professional venture capitalists investing in duds.

Professional VCs Compete Aggressively For Access

Most individual private company investors lack an edge, expertise, and a robust network compared to the professional venture capitalists who run funds. Therefore, the private companies an individual investor gets to invest in are likely those passed over by all other professional VCs. This is known as adverse selection, where individual investors only see the companies that nobody else wants.

Professional VCs, on the other hand, have much greater access to the best private company investments. Even the professionals often have to fight tooth and nail just to get an allocation into the best companies. This access to top private companies is what limited partners pay for.

Taking a step further, individuals often compete to gain access to top venture capital funds!

Example of a Failed Venture Capital Investment That I Thought Would Succeed

Take, for example, a company called Cameo. Cameo is an online platform that allows users to book personalized video messages from celebrities, athletes, influencers, and other public figures. Founded in 2017, the company aims to create unique, memorable interactions between fans and their favorite personalities.

During the pandemic, Cameo’s popularity soared as people were stuck at home. Instead of meeting friends for a birthday party or going out to dinner for a wedding anniversary, people found ways to give virtual gifts. It was a great idea!

I received a number of fun cameos from tennis players I followed, gifted by a friend. A newsletter reader even reached out to see if I’d be willing to record a one-minute message as a gift for his friend’s wedding. I did, and I got paid several hundred bucks.

The business model was simple: get interesting people to sign up for the platform and create video and audio recordings. These individuals would get paid a market rate, and Cameo would collect a percentage of the revenue. The business seemed easily scalable—all Cameo had to do was create the marketplace.

Cameo Historical Funding Rounds

Below highlights the various funding rounds for Cameo, the dates, and its investors.

I invested in a top venture capital fund that raised $600 million in 2018. In 2019, it started deploying capital, and one of its investments was in Cameo. The fund invested 4% of its capital, or $24 million, in Cameo during its Series B round. The post-money valuation was roughly $250 million.

Two years later, in 2021, Cameo raised a $100 million Series C round at a post-money valuation of $1 billion! Hooray! My venture capital fund had made at least a triple on its investment in two years, even after dilution.

Then, on March 13, 2024, Cameo raised a $25.1 million round, also called a Series C for some reason, at a reported valuation of only $100 million! Supposedly, existing shareholders have seen up to a 99% decline in valuation after the new funding terms.

Would Have Invested In Cameo If I Had The Opportunity

If my venture capital fund had asked its limited partners to co-invest with them during the Series C round at a $1 billion post-money valuation, I probably would have said yes to the tune of $25,000.

We were still in COVID at the time, I did a Cameo myself on the platform, and felt that a $1 billion market cap was nothing in this day and age. Furthermore, I knew smart and connected VCs who had thoroughly vetted the company for me.

If I had invested in Cameo, I would have lost all my money. Phew.

Why Did the Venture Capital Investment Sour?

Remember, 2021 was a boom year. Meme stocks were going crazy, tech stocks were on fire, and investors just couldn’t lose. In the end, investors lost big as the 2022 bear market hit, bringing everybody back down to Earth.

Cameo probably failed to grow its valuation because it raised too much money at too high a valuation, the pandemic ended, demand waned, and the company overhired.

Cameo’s 2024 Series C funding is considered a “crackdown” funding round. For new investors, a $100 million post-money valuation for Cameo seems attractive.

However, it stinks for me and other limited partners who invested in this venture capital fund, right? Not so fast! As I indicated above, VCs expect about 90% of their investments not to make money. Cameo will likely be part of that 90% in this fund.

The Winning VC Investments Made Up For The Losses

This fund that invested in Cameo made 50 investments. Out of the 50 investments, 7, or 14%, are grand slams worth about $1.5 billion based on a ~$175 million investment. Around 12 of the fund’s investments are in the green, totaling about $530 million based on a $300 million investment.

It just so happens that Cameo isn’t one of them. In total, the $600 million fund that began deploying capital in 2019 is now worth about $2 billion at the end of 2023. That’s about a 5-year compound annual growth rate of 27%. Not bad!

The main winner of the fund is its $25 million investment in Rippling, an HR enterprise software company, which was worth $542 million in the fund at the end of 2023. Given Rippling raised another round of funding in 2024 at a $13.4 billion post-money valuation, I assume the fund’s stake in Rippling is worth even more.

As an individual investor, would I have invested in Rippling at a lower valuation? Probably not. The founder left on bad terms with his previous company, Zenefits. Additionally, I didn’t understand HR management software and its potential. But the general partners did and knew the founder, so I was saved.

Individual Investors Have No Edge in Private Company Investing

Most of us are not professional investors or investing enthusiasts. Despite getting my MBA and working in equities for 13 years at GS and CS, there’s only so much time I want to spend investing in stocks.

With two young kids and other interests, I do not have the bandwidth to do due diligence on individual private companies. Moreover, if there is a hot private company I want to invest in, I won’t be able to get access unless I invest with an established venture capital firm.

Therefore, I will gladly pay a fee and a percentage of profits to private fund managers spending 40+ hours a week trying to invest in companies I have no access to. As you get older, it feels better to farm out money management responsibilities to free up time to do what you want.

Not only would I have invested in Cameo and not invested in Rippling, I would have also passed on Figma when it was valued at $500 million, a design company. Yet, Figma grew into a $10 billion valuation just three years later. The problem with only investing in what you understand is that you can miss out on so many other opportunities.

Letting My Private Investments Ride

My initial capital commitment of $140,000 in this fund in 2018 is now worth about $406,000 as of 4Q 2023. It would have been worth $462,000 if all $140,000 of the capital had been called. But, only $123,900 has been called after all these years. It usually takes 3-5 years for 100% of your committed capital to be called.

I’m happy to have met the capital calls over the years and locked up the money in these private companies. As long as these companies are executing, they should continue to grow in value. It’s also been nice to not have to experience visibility volatility over the years. All I had to do was keep on meeting capital calls, thereby dollar-cost averaging through good and bad years.

If you want to invest in individual private companies, please don’t. Only do so if you are willing to build a portfolio of at least 20 companies with similar investment sizes. Remember, professional venture capitalists build portfolios of 50 or more companies, expecting only 10% of them to provide outsized returns. I think that probability drops to 5% or less as an individual investor.

With up to 20% of my investable capital, I’d much rather invest in venture capital and other private funds every year. It feels much better knowing that professional private investors are focused on making profitable investments so I don’t have to.

Reader Questions

Do you have any private company investment winners? What’s your track record been like with investing in individual private companies? If you invest in venture capital funds, how have they done?

If you’re interested in investing in private growth companies, check out the Innovation Fund. It is an open-ended venture capital fund with a minimum investment of only $10. Unlike closed-end venture capital funds, you can see what the Innovation Fund is investing in and then decide how much to invest. You also have liquidity if you need it.

My personal goal is to invest $500,000 in private artificial intelligence companies within the year. I’m doing so partially through the Innovation Fund because I want exposure to AI companies such as OpenAI, Anthropic, and Databricks. The AI revolution is here, and I want to be a part of it. Fundrise is also a sponsor of Financial Samurai.

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