How Proper Information, Effective Risk Management, and Legacy Capital Can Solve the Funding Gap

Abstract

One of the articles in the Spring Edition of The Journal of Private Equity explores why positive risk-adjusted returns, namely alpha, has been limited to a select group of venture funds and investors. That article recommends possible causes and proffered solutions. This article explores in greater detail the (potential) answers to the chronic “negative alpha” typical of the venture asset class. The author also presents the most recent thinking on venture portfolio construction, and shared investment selection philosophies and practices from the public securities market (hint: picking stocks does not work). Included are insights from institutional investors that have heretofore avoided the venture asset class due to the chronic “negative alpha,” and how a new approach using Smart Beta filtering could attract more institutional capital earlier in the startup lifecycle. The interests and motivations of the modern Impact investor today are remarkably similar with the original roots, and could represent the next wave of capital flowing into early-stage entrepreneurial companies. Success may come with a lowering of the cost of capital for entrepreneurs seeking funding and the equity risk premium applied by investors, moving the efficient frontier on the asset class up and to the left.