How to Invest in Venture Capital

Ahead of any article about investing in venture capital, a risk warning is required. Venture Capital (or VC for short) is a high-risk asset class that is only suitable for sophisticated investors. If you’re an investing beginner or have no prior experience investing in unlisted equity or debt, then I suggest that you pick another major asset class to research. If you believe you meet the requirements then read on to find out how to invest in venture capital.

This article is not financial advice. If you’d like to receive advice on how to invest in venture capital then look at our guide on how to find a financial adviser.

How to invest in venture capital firms

How to invest in venture capital: at a glance

Here’s a summary of the key points in this guide to how to become a venture capital investor:

  1. Determine how much capital you can afford to invest in venture capital as an asset class
  2. Choose between fund type: vanilla VC funds, or tax-advantaged Venture Capital Trusts (VCTs)
  3. Research the best UK venture capital trusts or VC firms
  4. Choose whether to invest directly or through an intermediary
  5. Diversify as much as possible across the best UK VCTs
  6. Remain wary of investment scams

1. How much capital can you afford to invest in VCTs?

Venture capital firms can return in excessive of 30% per annum to lucky investors. But these high potential returns shouldn’t encourage you to load up your portfolio to the hilt with VCT investments.

That’s because these success stories are not the norm, and even attractive returns come with plenty of volatility.

Investing in small, unlisted businesses is one of the riskiest investment activities available. The rate of failure for small start-ups is high. For VC investors who took an equity stake in those companies, these failures translate directly into investment losses.

This is precisely why VCTs try to build a portfolio of 30 – 50 companies to spread that risk across many opportunities. Venture capitalists understand that statistically speaking, a large number of their investments will fail. They hope that with enough due diligence, they will extract more profit from their lucky investments than they will lose through their bad investments.

This leads us to a point about venture capital. A rule of thumb observed by many sophisticated investors is to not allocate more than 10% of their investment portfolio to unlisted investments such as VCTs.

That might feel quite small. If that is the case, then pick up some great books about portfolio management, asset allocation books or risk management books and look at the modelling of portfolio returns with high-risk assets.

Where portfolios are dominated by high-risk assets such as venture capital, the overall volatility of the portfolio leads to stomach-churning results and a deterioration in risk-adjusted performance. This means that, once you adjust for the greater risk taken, the portfolio actually returns less per unit of risk, than a more balance portfolio.

This is counterintuitive point which is why I recommend picking up a book on the topic to dive into it. In our guide to how to become an angel investor, we reiterate this 10% rule of thumb.

2. Using venture capital trusts versus vanilla venture capital funds

In the UK, HMRC gives generous tax breaks to venture capital funds that commit to using most of their capital to invest in small businesses. These funds are known as venture capital trusts or VCTs.

Not all venture capital funds meet these requirements; although most do. The perks of investing in a fund that meets the definition of a venture capital trust can be very attractive, particularly to wealthy investors with large tax bills.

Here’s a brief summary of the benefits available to VCT investors:

  • Income tax relief on 30% of the first £200k invested into a VCT each year. This effectively allows some investors to reduce their income tax bill by £60,000. This could be seen as a ‘discount on the investment cost’.
  • Up to £200k of dividend income from VCTs each year is tax-free
  • When you sell shares in a VCT, any gains made are exempt from capital gains tax (CGT)

The availability of these perks makes VCTs the obvious route of investment for venture capital investors. Funds which don’t qualify for VCT relief struggle to compete for the first £200k of any wealthy investor.

However, for ultra-high net worth investors, the caps on these reliefs means that after the first £200k invested each year, they begin to become more indifferent as to the legal structure of the fund.

3. Research the best UK VCTs

To help your research into the best UK venture capital trusts, we’ve created a fairly comprehensive comparison of UK venture capital trusts.

4. Choose whether to invest directly or through an intermediary

How to invest in venture capital will change depending on which VC fund you choose to invest in.

Some funds accept direct investment. You simply navigate to their website, register your interest for a live or upcoming funding round and wait to be contacted.

Other VCTs can be only invested via an intermediary, such as Further Finance (Read our Further review). These act as brokers, registering new clients and directing the proceeds to the fund.

The benefit to the fund is that they only need to deal with a handful of intermediaries rather than 200 individual investors, so this reduces the administrative burden of fundraising.

The main difference you will see between these routes are the initial and ongoing investment fees.

  • Some intermediaries add an additional investing cost in the form of additional upfront fees
  • Some intermediaries actually help save you money, by offering to rebate a portion of the initial investment fees which you may have been unable to avoid regardless

It all comes down to the rules of the fund and the offers made by intermediaries, and therefore it’s impossible to state objectively whether you’re better off going direct or through a broker.

5. Diversify as much as possible across the best UK VCTs

To increase your odds of landing a stake in the next Uber or AirBnb, it makes sense to try and invest in as many quality start-ups as possible.

Whereas on VCT might invest in 45 different start-ups, holdings in 5 VCTs would expose you to over 200.

The returns of stellar VCTs are often driven by them ‘striking gold’ with a start-up that delivers a 10,000%+ return on the initial investment. Diversifying across VCTs will increase your odds of finding your very own.

A barrier to diversification is the relatively high minimum investment required by VCTs. This tends to be between £5,000 and £20,000.

6. Remain wary of investment scams

When looking for VCT opportunities online, either directly or through an intermediary, be very wary of investment scams. Check out our guide on how to spot an investment scam to help protect yourself.

For more information about how to invest in venture capital safely, take a look at this handy guide from the Money Advice Service, about higher risk investment products, including VCTs.