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February 10, 2020updated 12 Feb 2020 3:24pm

Venture capital: keeping wealth in the family

By Asena Degirmenci

Intergenerational wealth planning is the process of transferring wealth on to younger generations smoothly and effffectively. Something that is making the process easier, while adding its own complications, is venture capital. Asena Değirmenci writes

Three of the main questions facing families with wealth are: how to best invest to sustain future generations, how best to engage the next generation and how best to ensure family unity endures.

Intergenerational planning is most effective with a long-term strategy. Planning ahead also allows the next generation to become involved in the evolving investing landscape, and gain a better understanding of the critical role that wealth planning plays in a family’s portfolio.

Venture capital (VC) offers the potential for attractive returns relative to public equity markets, often in a tax-advantaged manner, thus allowing the portfolio to generate wealth to support current and future generations.

 VC investing and tech

With a changing landscape, VC has become an integral element in long-term investment strategies. VC has presented itself as a platform for cross-generational exchanges and discussions on wealth planning.

There is a huge potential impact for investing and creating sustainability following the technological advances that have been made – be they from cloud computing, machine learning or artificial intelligence.

According to the Cambridge Associates private investments database, VC has generated compelling returns in relation to public markets, both in recent years and over a long-term period. Technological advances, strong entrepreneurial talent, and availability of capital and fund manager skills are all key factors and play a major role in creative investment opportunities across a number of different areas.

Evolving landscape

During the 2000s, VC investors experienced both big winners and big losers. Through the tech bubble, fund managers learned valuable lessons that can benefit the evolving landscape and further aid today’s venture investors. Since then, companies are more focused on risk management. Additional measures such as ‘incubator’ forums, a core community of advisers and setting aside capital for follow on needs all provide critical resources that allow start-up companies to find a solid product market fit and adjust themselves appropriately.

As a result, managers have been able to reduce dispersions on returns, and cut the impairment and capital loss ratios of the underlying universe of companies. According to the Cambridge Associates database, the capital loss ratio in the 1990s was more than 50%; since then, it has dropped considerably to just 20%.

Challenges

VC has often been considered to be too risky, and is often looked at with scepticism because of its historically high loss and impairment ratios. It is understandable to consider that with a number of start-up companies failing to return investment capital, the risk of capital loss is assumed to be high through VC investing.

The Cambridge Associates database suggests that throughout the years, VC has advanced considerably than it did in the 1990s, exhibiting a closer risk-return profile to global private equity (buyouts and growth). By expanding across multiple funds, the probability of overall loss is automatically minimised.

Each venture fund has an average of around 20-30 investments, therefore reducing the risk from single start-up companies.

Despite VC investing being more determinate than how it was a couple decades ago, the extent of manager returns is still broad. According to Cambridge Associates, when it comes to VC investing, manager selection is the key to attractive returns.

Inclusion

VC investing is looking set to become increasingly valuable in the next 10 years, given the muted expectations of returns for public equities. The importance of VC is highlighted by the clear and sustainable trends of private markets replacing public markets. Since the early 2000s, the number of publicly traded US equities has fallen by nearly half from 8,090 to 4,336.

Although all these companies will remain, they will have created considerable returns for investors – the longer the company remains private, the more returns are acquired by VC investors.

According to the Cambridge Associates: “The amount of money raised in VP represents a fraction of the market value of the industries being disrupted by many venture-backed companies, and a fraction of the total addressable markets of emerging business categories being created by VC.” The database reveals that VC at $340bn net asset value is less than 0.5% of the $85trn for global equity valuations.

Family values

The goal of VC investing is to make a difference while also making a return on capital. Including VC into a family’s long term investment strategy is best achieved by taking into consideration the perspectives, insights and experiences of all generations. Likewise, all generations can unify and incorporate their expertise, insights and interests that complement individual preferences for investment.

As a result, each family’s investment programme – through different perspectives, passions and personal values – can be personally tailored and be more meaningful and impactful to each participant. The traditional investing landscape is being altered through the number of technological advances that are transforming companies in every sector.

Intergenerational wealth planning is most successful when implemented through a long term strategy. VC investing has become a core component of this transformation, and has encouraged many families to reconsider their investment plans.

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