An Introduction to the World of Venture Capital

venture capital
When startups need funding, venture capital is one option
they might consider. Getting funding from a VC firm can
offer certain advantages to new businesses that may not be
able to get approved for traditional loans. Thanks to the
rise of crowdfunding, it’s now becoming decidedly more
mainstream.
Venture Capital Explained
Venture capital is a type of private equity investment. A
venture capital firm or individual investor extends funding
to startups that can grow over the long-term. The emphasis
is primarily on new companies that are looking for seed
funding to launch or scale operations, rather than
established businesses.
The idea behind venture capital is that the firms or
individuals who invest in them may see a sizable payoff
down the line if the company succeeds. Venture capital
isn’t a loan; startups don’t make payments back to the
venture capital firm monthly. Instead, venture capitalists
An Introduction to
he World of
enture Capital
Rebecca Lake
SmartAsset March 15, 2020
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are repaid for their investments in the form of equity
shares in the company.
That means venture capital can have a longer time frame to
generate a return. That’s especially true compared to
investing in a stock or mutual fund. Essentially, the firm or
investor may only realize a financial benefit once the
startup goes public and its shares begin trading on the
stock market. Also, if the company is acquired by another
company at a profit.
Startups that work with venture capitalists may transfer of
equity to investors for access to capital. Startup loans or
business credit cards may be funding options for new
businesses. However, they usually come with borrowing
cap that’s in the thousands or tens of thousands of dollars.
Venture capital, on the other hand, could provide millions
of dollars in seed funding for startups immediately.
Meanwhile, it doesn’t require them to meet credit score or
revenue requirements the way a business loan would.
Pros of Venture Capital Investing
venture capital
The main advantage of investing in venture capital is the
potential to reap big financial rewards if the company or
companies you’ve invested in do well. If a startup has a
highly successful initial public offering, for example, the
value of your equity share in the company could skyrocket
overnight. If you then sell your shares in the company, the
end result could be a substantial profit and return on your
initial capital investment.
Venture capital investing is also an opportunity for many
investors to give back, similar to angel investing. It’s a
chance for firms and individuals to pay it forward in a
sense and support businesses or industries that are
meaningful to them in some way. If a venture capital
investment includes an exchange of equity, the firm or
individual that’s doing the investing could also have the
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opportunity to play a part in the company’s decision-
making and management.
Venture Capital Cons
The chief downside of investing in venture capital is that it
can be exceptionally risky. Venture capital firms typically
have the resources and tools available to research startups
and are selective when deciding which companies to fund.
They also have the expertise and knowledge to get a feel for
which companies are likely to succeed and which ones
aren’t. But when that turns out to be wrong and a startup
tanks, the result could be a major financial loss for the VC
firm.
That’s why VC firms often invest in multiple startups at
once. They spread investment assets across multiple
companies to diversify and ideally minimize risk. If one or
more of the startups the firm backs fail, then there are
other companies that can hopefully balance out those
losses as they grow. Even one successful venture capital
investment could outweigh five failed ones if the overall
return is high enough.
How to Invest in Venture Capital
Traditionally, venture capital has been the domain of
investment banks and private wealth management firms,
though there are individual high net worth investors who
fund VC opportunities. Over the last few years, venture
capital has become more accessible to the everyday
investor through crowdfunding platforms.
Crowdfunding sites offer an opportunity to pool your
money with other investors to back startups. There are
several advantages, both for startups and investors. On the
startup side, crowdfunding platforms can make it easier to
access venture capital. In a typical VC arrangement,
startups have to pitch firms which can be a time-
consuming and frustrating process. Crowdfunding
eliminates that hurdle.
For investors, crowdfunding makes it possible to invest like
a VC firm without all the standard barriers to entry. While
a venture capital firm might be able to invest $5 million in
a new company, you might only have $5,000 to invest. But
by pooling your money together with other investors, you
can still grab a slice of the pie so to speak and invest in up-
and-coming companies.
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There are, however, a few things to keep in mind if you’re
considering venture capital investing through a
crowdfunding platform. As you compare platforms,
consider the following:
Whether the platform is open to both accredited and
nonaccredited investors.
What fees the platform charges to invest.
The minimum investment required.
How soon you can expect to see a return on your
investment.
How returns are realized, (i.e. dividend payouts).
Also, consider the timeline involved when investing in
venture capital. It can take years for a startup to get its
bearings and become competitive in the marketplace. And
even that’s no guarantee that it will be profitable. So
consider how long you’re comfortable typing up money in a
venture capital investment before diving in.
The Bottom Line
venture capital
Venture capital can be an attractive funding option for
startups bypassing traditional business financing options.
As an investment, venture capital could offer big returns.
ut that usually involves taking a bigger risk with your
money. Crowdfunding platforms can be somewhat more
cost-efficient.
Investment Tips
Consider talking to your financial advisor about whether
VC investing is something you should explore. Finding
the right financial advisor that fits your needs doesn’t
have to be hard. SmartAsset’s free tool matches you with
financial advisors in your area in 5 minutes. If you’re
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ready to be matched with local advisors that will help
you achieve your financial goals, get started now.
Crowdfunding isn’t just for venture capital investments.
Real estate crowdfunding, for example, is another way to
invest by pooling your money. The difference is that
instead of investing in startups, you’re investing in
property. This could be yet another way to diversify your
portfolio and increase returns if you lack exposure to
real estate.
Photo credit: ©iStock.com/BackyardProduction,
©iStock.com/Dekdoyjaidee, ©iStock.com/maybefalse
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