Venture capital investments are a way to make a large sum of money quickly. Or to lose all investments because such investments are precarious.
We have looked at what venture capital investments are, their pros and cons, what projects can be considered venture capital, and the risks of this kind of investment. And if you are interested in other investments, you can ask how to play Andar Bahar. This entertainment can help you earn money.
What Is Venture Capital?
Venture capital is a high-risk investment. Most often, an investor invests in promising new projects that are developing. The English word venture is translated as “risk,” “venture,” “dare,” or “risky venture,” which reasonably reflects the essence of such investments. The main risk of such investment is that the project will not bring any real profit or close before it begins to get it.
A venture investor invests in promising projects expected to bring a significant profit. In return, he receives shares or a stake in the company. Often these projects offer something new or uncharacteristic to the market. As a result, there is no guarantee of a return on investment.
That is, the main signs of a venture project are:
- New ideas;
- great prospects;
- high returns;
- big risks.
Principles of Venture Capital Investment
Venture investing has characteristics, attributes, and principles that distinguish it from other investments. Here are the main ones:
- Investments are attracted in the initial stages.
- The investor has no guarantees.
- The investor becomes a co-founder.
- One successful investment can override several unsuccessful ones.
Why Do People Invest in Venture Capital?
The most important reason people invest in V.C.s, despite all the risks, is the returns. Venture capital is the most profitable because the companies in which the money is invested grow and develop quickly and are thriving.
Venture capitalists invest in projects for profit because they want to develop technology or believe in an individual project. For example, those who support SpaceX help create an entire innovative industry – the creation of space technology.
These investors are often called business angels or angel investors. The term came from the theatrical sphere, where angels were called theater fans who invested in new productions.
Return on Venture Capital Investment
The Cambridge Associates U.S. Venture Capital, an index that tracks U.S. venture capital funds, shows that the average return on venture capital investments is 14.34% per year. That’s a figure for the past ten years. Over the past 25 years, the figure is 34.43% p.a.
At the same time, according to the Wealthfront study, 95% of the returns to venture capital investors come from 20 out of 1,000 companies, which is 2%. In this, venture capital companies are similar to startups: about 10% succeed, while 90% fail.
Pros and Cons of Venture Capital Investment
The main upside for an investor is the returns. The high returns encourage investing in venture capital, despite all the risks.
But here are the main disadvantages for the venture capital investor:
- High risk. Statistics of venture projects show that 75% of companies do not return to investors their investments. And 20% of startups fail in the first year, 30% fall in the second year, 50% close in five years, 70% packed in 10 years.
- Long wait. Venture investments bring profit on average 5-7 years after the acquisition. Therefore, they are not suitable for fast earnings. It still takes a lot of time to find promising projects. Venture capitalists invest in little-known and young projects, which are often not yet public and are not advertised in any way.
- There are fraudsters. Sometimes fraudsters and pyramid schemes are disguised as venture projects. In this case, the investor has no chance to return the contribution.
- High entry threshold. Sometimes you have to invest from $1 million to $5 million to profit.
Pros and Cons for Companies
Companies seeking venture capital investments have their pros and cons from such contributions. However, more often than not, a startup project has no other choice because taking out a loan from a bank is difficult because there are no assets to pledge.
The advantages of venture capital for companies are:
- It is possible to get financing without commitment. Venture capital does not guarantee repayment. If the project closes, its authors will not owe the investors.
- You can get knowledge. Often, venture capitalists are knowledgeable in the field they want to invest money. In addition, they have a network of contacts who can help with the new project.
- You can draw attention to the project. If a well-known investor invests a large amount of money in a new project, the media can tell about it. This way, the company gets additional publicity.
Disadvantages of venture capital for companies:
- There is a risk of losing control of the company. The project’s authors transfer a part of the company to the investors. If there are many of them, there is a risk of losing controlling interests completely.
- Sometimes you need to hire people from the investor. Some investors will only agree to fund the project if the company hires an employee from the investor’s side to join its staff.
- The investor may refuse to sign a nondisclosure agreement. It means that the investor may reveal information about the company that you do not want to disclose.
- Sometimes the investor may demand a refund. Some venture capital funds or investors may require ROI within 3 to 5 years.
How Do V.C.s Work?
The challenge for the venture capitalist is to find a company that generates high returns and offset the losses, if any, from failed investments. The winners here are those who guess which company will be a unicorn – worth more than $1 billion.
More often than not, a venture investor invests in several companies at once. The process looks like this: the investor chooses ten companies that are just developing and invests money in them. Three of them close in the first year, three more close in the second year, three more show average growth, and one grow so that it outweighs the losses of the other investments.
Because of these statistics, venture capitalists prefer to invest in many companies at once to increase their chances of profit. The profit itself will also depend on the stage at which the investor enters the project. Usually, in the early stages, the risks are higher, but the profits also grow.
If an investor starts investing later, he takes less risk. But, at the same time, he needs to invest more money because the company has already shown some stability—for example, the presence of clients or revenue growth.
The study also found that venture capital funds are only used for investments in the early stages of the project and are usually made for 5-7 years. According to Statista, over the past 20 years, the most extended average return on venture capital investment in the U.S. was in 2016 at 7.6 years, and the fastest was in 2000 (3.1 years).
An IPO is an optimal way for the venture capital investor to make money on a company’s stock. At that point, the business puts its shares on the stock exchange, everyone can buy them, and the investor can sell his or hers and make money.
Another option is to wait until someone else buys the company and sell him his share. It is also possible to sell the shares in a private transaction off the stock exchange, for example, to another venture capitalist.