How does the risk of Pre-IPO Funds differ from Venture Capital Funds?
Both Pre-IPO funds and Venture Capital Funds are funds that invest in unlisted equities, and have some similar risk - Exit Risk, Lack of transparency on valuations, Illiquidity risk etc. However, while both funds have a similar level of risk, there are some important differences:
\nMaturity of the Business
\n- Venture Capital Funds invest in early-stage businesses, often when the business model, unit economics, a path to profitability etc may yet be unproven. Business failure risks can be very high at this stage of business growth. Investing at such early stages can lead to disproportionally higher returns if investment calls go right, but also can lead to large losses of capital if the business fails to scale. \n
- Pre-IPO Funds typically invest in more mature businesses, that have reached a level of business maturity which can justify an IPO in 1-2 years. Business failure risk is a lot lower at this stage, and the fund typically aims to earn positive returns on every one of their investments (as compared to venture capital funds, where 90%+ of investments can fail and a few investments have to generate enough returns to make up the balance).
Illiquidity Risk
\n- Venture capital funds are typically longer-tenured funds (7+ years) and investors have to be comfortable with locking in their capital for an extended period of time. \n
- Pre-IPO funds are typically shorter-duration funds (typically around 5 years), where investors can expect to start seeing some capital being returned within a 3 year period.
As a category, Pre-IPO funds are much lower in terms of risk-reward as compared to Venture Capital Funds. Venture Capital funds are accordingly more suitable for more aggressive investors, who are willing to take substantial risks in exchange for the potential of outsized returns (25%+ assuming investments pan out well). Pre-IPO funds are relatively lower risk, and as long as there is a buoyant IPO market available around the time of exit, these funds should be able to geneate a reasonable return with a higher level of consistency.
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