So a conversation that we have seen swirling around a lot lately is the ability to increase access for anyone to invest in alternative assets, particularly venture capital. Venture Capital has largely been an asset class exclusively reserved for “Accredited Investors”, that is individuals, couples, or business entities that meet certain income or net worth thresholds (as if having money makes you a good investor, but that is a different story for another time). Several crowdfunding and other alternative investment platforms have tried tackling this problem through platforms that enable individuals to make their own investments which is great, but the allure of a “fund” will always pull in founders given that a rockstar GP brings more to the table than just the capital she or he provides the founder. Perhaps the solution is already out there on display? To see what we are talking about we will need to take a trip across the pond to the U.K. where they have VCTs or Venture Capital Trusts, let’s dive in.
A VCT is a publicly-traded company that is structured similarly to a VC fund only instead of having LP capital, the VCT sells shares to the public and the proceeds of those stock sales are placed into a trust that then managed and distributed by a management company into private, unlisted startups just as any VC fund normally would operate. VCTs typically invest in a 70/30 split of equity and debt meaning that they generate both short-term cash gains from debt repayment as well as long-term upside in the equity positions that they take in startups. As both, the debt is repaid and the equity is able to be liquidated those returns are passed by through the trust to the shareholders in the form of dividends. Want to know the best part? For the shareholders, the dividends (up to a certain amount each year) are free of income taxes and shares in VCTs are capital gains tax-free when they are sold.
Now there are some interesting mechanics behind VCTs that could promote a really interesting dynamic for a VC fund that has exposure to the public markets. One, VCTs are capped at how much capital they are able to invest into any one startup in a calendar year. This could promote healthier competition amongst startups that need to raise smaller, more frequent rounds. The only issue here is the execution of venture financing will need to become far more streamlined if founders are forced to raise on a more recurring and shortened cycle. (Though if you raise priced rounds more frequently, growing companies will lead to more markups and a net increase in the asset value of the VCT).
The second interesting dynamic of VCTs is that they are required to split their investable capital into equity and debt investments 70/30. By requiring VCTs to invest some of their capital into debt the UK regulators force the management company of the VCT to do greater due diligence to responsibly underwrite the debt investments. This heightened level of due diligence should lead to investments in better companies overall.
Now there are a few unknowns with VCTs, like what happens if an activist investor takes action? How does a company that shuts down or has a down round affect the VCTs stock and or dividends? There are still a lot of questions around how a public fund would behave with the events and activities that are so common in publicly traded companies.
There is tremendous potential for a VCT structure to offer venture returns to the general public. Research on VCTs has shown that they return 166% of their capital over a ten-year period (for reference, depending on what research you read VC funds average 144–230% over the same 10 year period). If VCTs are able to consistently produce those returns, they could give the upside of venture to the mass market that they have to accredited investors over the last 20 years.
Could a publicly-traded VC fund be the answer we need to expand access to venture and provide founders with a new and unique channel to raise capital?