More Evidence Venture Capital not Worth the Risk for Ultra-High Net Worth Investors
Softbank’s Vision Fund Failure the Latest in a Long Line of Poor Venture Capital Returns
The verdict is in for Softbank’s first Vision Fund, and it’s not good for ultra-high net worth investors who look to venture capital as a place to earn big returns. As you’re about to see, venture capital has an underwhelming history of subpar rewards, enriched fund managers, and investors left with nothing, or less.
Here’s the key issue you need to settle before investing in a venture capital opportunity: Does the act of funding startups and launching other people’s ideas tie deeply to your values and priorities? Is this act more important than your returns, or lack thereof? If so, and if you have funds to spare without jeopardizing your own financial stability and lifestyle, then venture capital may be a good vehicle for you.
In other words, if it’s fun or fulfilling, and doesn’t put you at risk, then go for it.
But if your goal is to maximize your investment performance and secure your wealth for the rest of your life and beyond, venture capital is one of the last places you should be investing.
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The Softbank Venture Capital Failure
$100 billion was invested in Softbank CEO Masayoshi Son’s grand experiment, from the likes of Larry Ellison, Apple, Saudi Arabia, and Qualcomm. But because of failures like WeWork, and stubborn under-performers who have yet to turn a profit like Uber, Vision Fund 1 lost $18 billion. More precisely, according to CNBC, Fund 1 has so far invested in 88 startups with $75 billion, and lost $17.7 billion.
Those losses have cast great doubt on Son’s plans for a Vision Fund 2, and few backers have committed any capital.
As one tech investor relayed to CNBC about a backer of Fund 1 from Abu Dhabi, they are “super spooked by the performance,” and that “Softbank is too ill-disciplined. Unfortunately there aren’t lots of great options to park your billions somewhere.”
The quote belies the misguided thinking of too many who invest in venture capital and ignore its risks. As an ultra-high net worth investor, more time should be spent considering what you want to accomplish with your wealth. And this investor is simply wrong.
There are many great options to “park your billions,” as he puts it. Venture capital simply isn’t one of them.
Stubbornness Runs Deep
Despite repeated venture capital failures on both the smaller scale and headline-grabbing scale, many venture capital believers seem unable to grasp the high risk and poor returns that have plagued their industry for decades.
CNBC names one from Index Ventures, who says, speaking of the Vision Fund, that raising so much money on the front end “was a smart way to break through so I suspect the model can work.” He says, “We still don’t know whether Softbank’s underperformance is due to their strategy or their execution.”
But – does it matter what the reason is?
They lost $18 billion!
This is 24% of the $75 billion they have spent so far from the first Vision Fund. A 24% loss – and don’t forget this was during good economic times, before COVID – is about as bad as anyone could do. You wouldn’t lose that much even by plunking quarters into a slot machine in Vegas, because slots are pre-programmed to make a certain amount of money. And they don’t make 24% of what people gamble (though, $75 billion is a lot of quarters…).
Another stubborn believer, from Deutsche Bank, declared to CNBC that the Vision Fund shouldn’t be judged by early mistakes, and that it would rebound within 18-24 months. He said, “I guarantee you will see the outcome of our investments will change.”
Is he still saying that now that the global economy has cratered?
Venture Capital Is a High-Risk, Low-Return Investment Choice
The history of venture capital proves that the failure of the Vision Fund isn’t an exception. It’s the rule. The exceptions are the success stories, like Google and Apple. The failures are the norm.
Harvard Business Review says that “many more venture-backed startups fail than succeed,” and that “for more than a decade the stock markets have outperformed most of them, and since 1999 VC funds on average have barely broken even.” It later says that since 1997, venture capital investors have received less back, cumulatively, than they have invested and that the average fund “breaks even or loses money.”
The New Yorker says that 80% of venture capital investments “don’t pay off.”
These are staggering numbers.
That’s a failure rate spread out over 20-years, through booms, busts, bulls, and bears. How much could you have earned using a smart, optimized, customized investment plan over that same 20 years?
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Imagine an ultra-high net worth investor putting $100 million into venture capital back in 1997. Now, over 20 years later, that investor may have less than $100 million to show for it. Had that same investor put that $100 million into even the simplest investment approach – a CD earning 2% per year – they would have nearly $150 million.
Had they invested it in a customized plan optimized to perform at a level that assures them of achieving all their short and long term financial and lifestyle desires and outcomes, they could have had a lot more by 2020.
These are the stakes we’re talking about.
Why would you invest tens or hundreds of millions in an industry with an 80% failure rate, when you could take that same money and multiply it many times over a 20, 30, or 40 year period?
Some Other Well-Known Venture Capital Failures
We’ve written about some of these before, but it bears repeating.
Theranos is a well-known venture-backed company that promised a revolutionary blood test process. It turned out to be a fraud. But not until hundreds of millions of venture capital had been sunk into it. That’s hundreds of millions of dollars of hard-earned money from ultra-high net worth investors that could have been invested in countless other ways – ALL of them smarter than this.
Zume promised to build a pizza empire built on the silly notion of installing ovens inside the delivery vehicles so the pizza would bake while being delivered. This is a solution in search of a problem. Yet, according to The New Yorker, Softbank (again) invested $375 million into Zume, even though they never expanded beyond a tiny section of the San Francisco Bay Area.
Zume has since laid off half their workers and is now working on developing “compostable molded fiber packaging.” Splendid. Maybe they were able to donate the oven-trucks to some nonprofits.
Juicero raised $118 million to build a business around Wi-Fi-enabled juice packet squeezers. You read that right; some things just can’t be made up. They shut down in 2017.
MoviePass rose and fell before anyone even realized what had happened, blowing through $266 million of venture capital money in just one year.
The list of well-known failures is long. The list of lesser-known ones even longer. This is the stuff of an 80% failure rate, and a cumulative negative return over a 20-year period.
Even in Rare Success, Venture Capital Investors Lose
As if an 80% failure rate spread over decades wasn’t bad enough, imagine you were lucky enough to break through that and find yourself the beneficiary of a rare venture capital success story. Even in that, you are not getting as good a deal as you deserve.
As the Harvard Business Review makes clear, typical venture capital funds charge “an annual fee of 2% on committed capital over the life of the fund – usually 10 years.” They also charge a percentage of any profits, if any. So you are paying 2% per year on whatever you invest, for ten years. In effect, you’re paying 20% to the firm, and hoping to win back that plus the remaining 80%, and then actual profits. But they will take a share of those too.
Why does this matter? Because the venture capital firm doesn’t care if their investments pay off or not. They are getting paid by you regardless. If you invested $50 million in a venture capital firm, the firm would be making $1 million per year off your investment – no matter what happens!
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What are you getting for that extremely high annual 2% fee, plus more fees if the investment succeeds? High risk, an 80% failure rate, and a 10-year loss of liquidity. In many ways, it is worse than an annuity, because at least with an annuity you are guaranteed something if you stay alive long enough. (And we do not recommend annuities as a smart investment choice either).
A Better Ultra-High Net Worth Investment Approach: Wealth Permanence
What do you want your wealth to achieve over the next 10, 20, 30, or 40 years? What do you want your life to look like? What do you want to be doing with your time? What do you enjoy? Who do you want to spend it with?
This is how to initiate the process of creating a customized ultra-high net worth investment plan that will not achieve negative returns 20 years later. Build it around your desired lifestyle outcomes and experiences.
Pillar Wealth Management doesn’t create plans that project to earn a specific rate of return. We create plans that project to achieve your desired lifestyle outcomes. Read that again. Make sure you note the significant difference between that and what most other financial advisors offer.
Whatever investment performance is required to achieve your desired lifestyle outcomes, we create a customized plan that will exceed those outcomes, and achieve ‘wealth permanence.’
Wealth permanence is what it feels like to live in what we call the Comfort Zone. This is the place where you can relax, knowing you and your family will be more than taken care of, for life – no matter what.
Does “no matter what” include the coronavirus recession, which may well last for years?
Yes! Even in this recession, our clients are not worried. With our approach, you can practically ignore recessions. See why. Because our plans are 100% customized and built upon a process we will explain in brief in a moment, each investor can remain in the Comfort Zone no matter what. All we have to do is adjust their plans in one or more of five areas:
- How much you spend
- How much you save
- How much you leave to your heirs
- The timing of planned major expenses
- Risk tolerance
These are the only five things you, or anyone else, can control. You can’t control the markets, or the economy, or the politics. But you can control these five variables.
In a down economy, to remain in your Comfort Zone, you may have to reduce spending for a time. You might have to increase savings, or adjust what you planned to leave your heirs. You might need to delay some major expenses you had planned. And you can adjust your risk tolerance, which may change your investment performance to bring a bit more stability.
Because these five variables are intertwined with your investment plan, by adjusting these and re-running your long term projections, we can determine what changes you must make in your life to preserve your wealth permanence.
What are our projections based on?
We have developed a way to incorporate historical market performance data from the last 100 years into our investment planning process. By looking at how the market has performed in booms, busts, recessions, expansions, inflation, wars, technological innovation, and so much more, we can calculate how your portfolio would have performed during those times.
Building on that, we have developed 1000 ‘what if’ scenarios, market performance simulations based on the historical performance data. We run your portfolio through those 1000 simulations. If your desired lifestyle outcomes – what you really want – are all exceeded in 750-900 of those simulations, you are in the Comfort Zone.
So this Comfort Zone isn’t a touchy-feely concept. It a mathematically-derived, historically-backed position of wealth permanence and financial serenity.
Which has more risk? Venture capital and its 80% failure rate? Or our process, which has adjustable risk tolerance. The stubborn investor in venture capital quoted earlier “guaranteed” a positive return in 18-24 months, despite Softbank’s track record of losing billions, before the coronavirus recession arrived. Now, he has no path forward.
Us? We simply go in and adjust one or more of the five variables listed earlier until your plan returns to the Comfort Zone, and you can keep relaxing. Even in a pandemic-fueled recession.
Which option do you want? Seems like a silly question at this point.
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