For those of you young enough to be going to nightclubs, you know the allure of the hot club with a velvet rope blocking the entrance. Behind the rope lies excitement, mystery and happiness. After you pay the cover charge.
Most of us have moved on from that stage of our life, or only actually experienced it via the movies. But here is the point. Investment minimums are not cover charges. You don’t invest the minimum to get in the club. You invest the minimum if that is the right allocation for a given investment based on your capital availability. Let’s unpack that Martian-speak.
When we inquire about investment minimums, the objective should only be one thing: Does the minimum work within my investment strategy? If a fund requires $500K minimums and I have only allocated $100K for alternative investment funds at this point, the minimum doesn’t work for me. However, that’s just the starting point.
Smart investment strategy is going to include at least a few key factors. (note: we can overcomplicate anything, but lets keep this straight-forward)
– How much capital do I have to invest this year?
– How much of that do I want to allocate for “alternative” investments like venture capital funds or direct investments? (The decision between fund investing and direct investing is an entirely separate area we have covered extensively in our blog posts.)
– Once I have a total allocation in mind, I have to determine how much of that I am going to invest in any single deal…fund or direct. (Note: mathematically you are better off investing a higher percentage in diversified funds than you are a single allocation. If you invest in single deals, you should be prepared to essentially build a diversified portfolio of investments over time. There is no perfect number underlying this strategy, but some statistics point to somewhere between 8 and 12 investments being the sweet spot.)
– Finally, I need to ask an important question which is a bit of reverse engineering of this issue. If this investment performs at the expected target range or better, will I be happy with the returns I generated from the outcome? Here is an example of how to process this.
Let’s say you decided to invest in Intuitive Surgical in their Series A round. Their investment minimums were $10,000. You invested $10,000 because that got you “into the deal.” However, you had $250,000 you could have allocated. Certainly it didn’t make sense at the time to invest all of your $250,000 into one company. In the rear view mirror you wished you did, but that wasn’t rational based on the information available at the time.
On the other hand, $10,000 was probably too little. Did you do well with that investment? Absolutely. But across an entire portfolio you need to have proper allocation to ensure you ride the winners with sufficient portions of your allocation. In other words, for every Intuitive Surgical in your portfolio there are probably a half dozen Sock Puppets. At the time of investment, we truly have no idea which is which. Anyone who professes to know is kidding themselves. It’s all about probability.
Obviously this example is extreme to make the point. We can do reasonable things to avoid Sock Puppets and we can determine that certain deals probably warrant a slightly higher allocation than others. We can think of this as grades (or probability)….we place a bit more in the “A” potential than we do the “B” and more in the “B” than we do in the “C”. We avoid the D and Fs.
Hopefully this provides some food for thought when trying to determine how much to invest in a given asset. The overarching principle applies to any asset…both public and private.