The time machine approach to VC investing

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Back in 1999, Ron Conway, a well known Venture Capital (“VC”) investor, invested roughly $25,000 in Google. Supposedly he was actually trying to meet the CEO of another startup in the same building, but Larry Page and Sergey Brin happened to be there instead… That's some luck right there! Conway immediately recognised the potential of Google and made the investment. It turned out to be one of the most successful investments in the history of Silicon Valley. There are countless investments where luck and timing played a big role like this, but the point I’m trying to make is simple: timing is everything. When you invest really matters but it’s hard to predict when a good entry point is. And it’s even harder to predict a good exit window. In other words: we can’t all be like Ron Conway. That’s why Jaap Vriesendorp’s firms, Welt Ventures and Marktlink Capital, have come up with something they like to call: ‘the time machine approach to investing in Venture Capital’. Put simply, they invest over extended time periods and company stages to effectively diversify their investments.

Venture is volatile: timing is everything

Investing in VC is like riding a roller coaster blindfolded — exciting, exhilarating, sometimes stomach and almost completely unpredictable. Whether you're investing at the earliest stages or the latest stages, timing is crucial, and data shows that the timing of your investment has a significant impact on your returns.

VC follows something called the "power law". In simple terms, the power law means 20% of your investments will generate 80% of your returns. A study of over 1000 VC funds from 2000 to 2022 confirmed this, finding that 80% of returns came from just 5-7 of the 23 years in which investments were made, highlighting just how important it is to invest over a period of years. If you don’t, you run the risk of missing out on one of these outlier years.

It’s about entry valuations and exit windows…

Investing in essence is pretty straightforward. You should buy low and sell high (simple 🙃). In the realm of VC investing, a key indicator of ‘buying low’ is understanding the entry valuations at each stage of a company’s life cycle (seed, early, growth etc.). Startup valuations have fluctuated significantly since 2019, with 2021 seeing record highs followed by rapid declines in 2022 and 2023. As of 2023, valuations are trading at, or below, prices seen back in 2020. This suggests that today presents an opportunity to enter at a lower price compared to recent years.

And entry valuations are just one side of the story. Money is made at the exit. About 80% of VC exits happen via strategic acquisitions or Private Equity buyouts. However, by far the most value is created through IPOs which represent about 60-70% of returns! Therefore, only a handful of IPO exits create the most value for VC investors.

So what does this mean? It means that in order to sell at the highest possible value, companies need to IPO. And in order for companies to IPO, they need to be great companies. But that's just the cost of entry! The IPO window needs to be favourable too. And a favourable IPO market is dependent on many external factors such as interest rates, economic outlooks or advancements in technology. There’s a huge difference in the number of companies that IPO each year, reinforcing the fact that timing is critical. And while it’s difficult to judge entry valuations, it is practically impossible to time exit windows.

In summary so far

1. when you invest matters;

2. entry valuation is important; and

3. it's near impossible to time exit windows.

So what’s the solution? Well, Jaap’s firms, Welt Ventures & Marktlink Capital, take a three principle approach to investing in a time diversified way:

Principle #1: Diversifying the entry valuation

The first principle is to diversify the entry valuation. As we touched on earlier, entry valuations fluctuate every year and data showed that 80% of the returns from a 22 year period happened in just 5-7 of those years. In order to catch one of those outlier years with an optimal entry price, you need to be consistently investing over a number of years. This way you’re diversified across entry valuations.

Principle #2: Diversifying the exit window

The second principle is to diversify the exit window. VC is typically distinguished by three different strategies:

1. seed stage (pre-seed and seed);

2. early stage (series A and B); and

3. growth stage (series C+). 

The important thing to note here is that investments in each stage have different holding periods. This ranges between 1 and 10 years, on average, with seed having the longest holding period and growth the shortest. By investing equally in each stage, you diversify across investments with varying exit windows.

Principle #3: Investing in primaries and secondaries

The third principle is to not only invest in primaries (purchasing newly issued shares directly from a company) but also in secondaries (purchasing shares from an existing shareholder like an employee or investor). Purchasing secondary shares allows for greater diversification over additional years, further spreading the risk of both entry valuations and exit windows. Secondaries are also generally easier to sell and have a shorter time to exit if held.

So to conclude, if you aren’t Ron Conway, don't try to time the market. By applying a ‘time machine approach to investing in Venture Capital’ you allow yourself to diversify both your entry valuations and exit windows.

A big thank you to Jaap Vriesendorp for allowing us to rewrite his original article for all the “Unsophisticated Investors” out there. Consider yourself an investment savvy individual? Well ooh la la. In that case, you can find his original here, which goes into far greater detail.

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The Unsophisticated Investor is brought to you by Scott & Rob, the founders of PitchedIt. We’re both sick of private markets being a playground exclusive to the ultra-wealthy so we started a company to challenge the status-quo. PitchedIt’s singular focus is to unlock private markets for Millennial and Gen Z retail investors and help them build wealth through the highest performing private market opportunities.

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PitchedIt Co-Founders