The term ‘venture capital’ or ‘VC’ means different things to different people. In short, it refers to investors who collectively invest in a portfolio of early-stage businesses or start-ups.
The first business to list on Catalist’s Public Market (Matū Iramoe) is a deep tech venture capital fund – and you can find out more about that by visiting their page on our Market – but rather than talk about their offer, we thought it would be helpful to explain a bit more about venture capital in general. What is it? And in particular, what is a listed venture capital fund?
The word ‘venture’, meaning “to start or do something new or different that usually involves risk” combined with the word ‘capital’, meaning, “wealth in the form of money or other assets”, is a great starting point to understand venture capital – which involves investing in new and often higher risk businesses.
Early-stage businesses tend to have a higher risk of failure than larger, more mature businesses. This can be for a whole series of reasons, but as early-stage businesses are just starting out, many of them will encounter issues commercialising their products or services.
One reason people invest in potentially higher risk investments is the expectation “the higher the risk, the higher the potential reward.” The greater the amount of risk an investor is willing to take on, the greater the potential return. However, investors need to understand their own risk appetite before choosing a higher risk investment – we’ve talked about similar issues in our previous blog on the pros and cons of investing in SMEs.
In a venture capital fund, by investing in a diversified portfolio of early-stage and start-up businesses, and actively helping them to grow, investors usually aim to achieve significant returns, even if one or more of the portfolio of businesses fails. The aim is that gains from the successful businesses will more than outweigh the losses from any unsuccessful businesses. That being said, like any investment in smaller businesses, there is always the risk that the investor can lose some or all of their investment, if the businesses in the portfolio perform badly.
Most people assume venture capital investments are only open to a privileged few – an exclusive club of wealthy investors who can afford to invest huge sums of money. Often this is true, with most VC funds only being open to investors who meet certain ‘wholesale investor’ criteria. Globally, however, there is a growing trend for some of these venture capital portfolios to open to the public. For example, in July this year Forward Partners, a well-established London-based venture capital firm, listed its shares on UK’s AIM market, which is the UK’s stock exchange for smaller businesses. Other UK listed venture capital funds include Draper Esprit and Augmentum Fintech.
By listing on a recognised stock market, these VC funds not only open up potential wealth-creation to all investors, including those who don’t meet the ‘wholesale’ investor criteria, but they also bring some ‘liquidity’ to the investment, which means the ability for investors to sell their shares – something that is often not possible in an unlisted VC fund. Investors in an unlisted VC fund will usually be expected to remain in the fund until the fund sells, or otherwise exists all the portfolio businesses it has invested in.
Now we know what venture capital is, and who can typically invest in it, what is a VC “fund” and how might it differ from other funds you may be more familiar with?
Contrary to a common perception, a fund itself is not a legal structure – rather it is an approach to the collective investment that could take a number of different legal structures. Under New Zealand law a fund is defined as “a defined pool of assets that are held for the benefit of a group of investors and that are managed together under a single investment mandate”. In plain English, any structure where investors come together to collectively invest is a fund.
Wholesale venture capital funds are often structured as limited partnerships, which give investors flexibility to manage their own tax affairs in relation to the investments. However, for listed venture capital funds, an investment company structure is common, where investors buy shares in a company and the company uses those funds to invest in the portfolio.
The investment company structure will be familiar to many investors who may have already invested in listed investment companies on the NZX, such as those provided by Fisher Funds or Booster. It is a cost-effective fund structure, where investors take an ownership interest in the investment company and the company then invests for the benefit of its shareholders (investors).
KiwiSaver funds usually use a ‘managed investment scheme’ structure, where investors own ‘units’ or economic interests in the portfolio of investments, rather than ownership of shares. These managed investment schemes require a licensed manager and licensed supervisor to oversee the management of the investments and to hold the assets on behalf of the investors. Investment companies (and listed VC funds structured as investment companies) differ, in that investors get the protections of being a shareholder in the business and don’t necessarily have a licensed manager and licensed supervisor. Shareholder rights include protections such as being able to vote on the directors of the company and any resolution to change the company constitution. Shareholders are also entitled to a proportionate share of any distributions or dividends made by the company.
Some investors may question whether having a fund’s management team selecting and working with the early-stage businesses is just adding additional costs, when compared to investing directly into SMEs. Isn’t investing directly into businesses what a stock market should be about? Well, it’s right that there will be additional costs to cover the venture capital fund’s management and other activities – for VC Funds with an active management team, these costs can be relatively high, and investors should make sure they understand all the costs before investing. However, VC funds often provide more than just money to the businesses they invest in. As well as providing a team of experts to research and select their portfolio investments, VC funds generally help the businesses grow by connecting them with key industry contacts and sales opportunities, for example. This can be a more efficient way for these early-stage businesses to access people with these skills, rather than employing their own experts in these fields. Additionally, some of the early-stage companies that VC funds invest in may not be ready to individually list, even on a growth market like Catalist, so it’s unlikely you’d be able to access these sorts of investments without a VC fund.
There is no one correct structure for financing SMEs. Catalist will be supporting direct investments into SMEs as well as investments in listed funds. As New Zealand’s stock market for small and medium-sized businesses, we see our role as giving new opportunities to all SMEs in the ecosystem, and new investment opportunities to New Zealanders, whether that’s through supporting existing funds, or listing other securities, such as individual company shares.
Given the term ‘venture capital fund’ really just tells you that something is a collective investment structure for investing in early-stage businesses, and that the fund’s investment team is likely to actively assist those businesses to grow, it is important to read all the information provided about the investment strategy and structure of a particular VC fund, and how their existing investments are performing, before investing. For any investment companies listed on the Catalist Public Market, that information will be accessible to everyone on the relevant page for the business, on our ‘Market’.
For investors interested in investing in a listed venture capital fund, you can find out more about Matū Iramoe here. For those investors who are interested in investing in SMEs directly, rather than through a fund, keep an eye on our Market page and we’ll announce our first IPO for a non-fund company soon.
By Colin Magee