Contrary to conventional wisdom, SyndicateRoom’s latest study reveals that an investment strategy of 'radical diversification' could help you beat the returns of not only the infamous TV Dragons, but also most professional venture capitalists.
Think you could outperform Dragons' Den? SyndicateRoom’s latest research agrees
Our latest study tracked every UK startup that raised seed or venture equity finance in 2011, for which reliable data was available: that's 506 in total. This includes now-household names like TransferWise, The Culture Trip and Nutmeg.
Using the same dataset, we looked at the VCs and Dragons that invested in this cohort to determine their 2011 startup portfolios. Comparing the performance of these portfolios with that of the cohort as a whole, we discovered that radical diversification can help you outperform VCs for one very important reason: by picking and choosing just a few businesses to back, these big investors are very likely to exclude the companies that go on to perform best.
So, if a large and broad cohort of startups outperforms the Dragons and most VCs, this begs the question...
IS IT TIME FOR A STARTUP INDEX FUND?
Overall, the cohort of 506 startups grew in value at an average rate of 28% per year between 2011 and 2018 (compound annual growth rate, or CAGR). Over the seven years, it saw:
86 companies enter venture stage
74 companies enter growth stage
170 companies become zombies
Had you invested £10,000 in the full cohort back in 2011, by the start of this year your portfolio would have been worth £72,800. Given that the majority of the 2011 raises will have been eligible for EIS tax relief, the gain for qualifying investors would have been even greater.
By comparison, publicly reported investments made by the Dragons in 2011 and 2012 grew at an average rate of 16% up to 2019. Our data also followed the 2011 portfolios of 479 VCs, which together grew at 19% CAGR.
Indeed, based on investments made in 2011, only 38% of UK VCs were able to outperform the startup cohort as a whole. This means that most VCs would be better off picking their investments at random, rather than trying to pick the ones they think will succeed.
After carrying out repeat simulations of various investment strategies (100,000 simulations per strategy), we found that one of the most successful was to spread your risk among as many companies as possible. We dubbed the strategy ‘radical diversification’.
We simulated investing into companies that raised between £500,000 and £5m in 2011 to create portfolios of varying sizes. The simulations assumed that a fixed amount was invested into a single round of each company, with no follow-on investments being made.
On average, a portfolio of 30 investments returned 3.7x of the initial investment in total over a seven-year period; when diversifying even more dramatically into 80 companies, this figure returned 4.7x.
Radical diversification continues to hold true when applied to smaller startup rounds (£150,000–£2m), though the rate of return slows once the portfolio reaches around 30 investments (2.3x return; here a portfolio of 80 investments averages 2.5x return).
This strategy allows investors a much higher chance of backing massive success stories like Funding Circle, which more than pay for any failures in the portfolio (according to Companies House, Funding Circle’s 2011 investors saw a staggering 231x return on investment from its 2018 IPO).
Read the full report free at Beating the Dragons: How Radical Diversification Can Outperform VCs, including full findings, charts and methodology.
These materials are written and provided for general information purposes only. It is worth remembering that while a significant study for the industry as a whole, this report nevertheless uses a small sample size which limits the reliability of assertions drawn from the data.
The content is solely the opinion of SyndicateRoom and/or other contributors and research from third parties. It should not therefore be relied upon in making any investment decisions.
You should not invest in any investment product unless you understand the nature of it, along with the extent of your exposure to risk. You should be satisfied that any product or service is suitable for you given your financial position and investment objectives. Where appropriate, you should seek advice from a financial advisor in advance of making investment decisions.
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