Venture funds as a way to invest in startups. The principle of operation, advantages and disadvantages of venture investments
Many wealthy private investors are not interested in investing in ordinary assets. They are looking for riskier, and therefore more profitable options for investing money. One of these alternatives is venture capital investments. In simple words, this is an investment in startups.
The concept and structure of venture funds
Suppose you are a young ambitious scientist or entrepreneur who has a brilliant idea, but does not have the money to implement it. In such cases, the project needs investors who will not be afraid to invest their own funds in order to get a result after a certain time.
A venture fund is an investment fund that invests exclusively in innovative projects and startups. A venture investor will not be interested in a regular business plan, therefore, in order to receive financial support, a venture project must be:
- innovative, that is, to offer something fundamentally new;
- technological, which implies the embeddability of the project in the technological way. The current technological cycle is focused on the development of artificial intelligence, genetic engineering, nano- and biotechnologies, as well as other innovative industries;
- scalable, that is, capable of developing new markets up to the world.
Structurally, a venture fund is a kind of basket in which assets received from various investors are collected and which are used to finance various startups. At the same time, in addition to investors and the fund, a management company participates in the chain.
The principle of operation
A venture fund operates on the following principle: by acquiring a controlling stake, it invests in potentially promising, but risky projects and manages them until the payback period. I must say that the startup development process is long and averages 5-8 years.
At the same time, it is important to take into account the risks of venture investments. In practice, most projects do not pay off, and only a small part of them really makes a big profit.
Only 20-30% of the projects will more than recoup the investments and cover the losses of the fund incurred as a result of unsuccessful investment. That is why the venture fund finances and promotes no specific project, but supports many startups at the same time.
Such funds are not burdened with legislative regulation and control by the Central Bank. They are not subject to licensing, they do not need to monitor their credit rating and financial liquidity, but investors acquire a stake in the promoted company, which allows them to get the right to vote and influence the further development of the project.
Types of venture funds
The classification of venture funds is based on their features and these are the types that are commonly distinguished:
- By sources of investment:
- corporate;
- public and private-public.
- By directions:
- funds investing in Russian projects;
- funds investing abroad.
- By coverage:
- funds with an extensive network of representative offices throughout the country;
- funds covering the territory of one or several regions.
- By industry orientation:
- aimed at information technology;
- aimed at the real sector of the economy;
- universal.
- By the volume of the investment portfolio:
- large ($150 million or more);
- average ($100 – 150 million)
- small (from $ 50 million).
- By investment stage:
- starting;seed funds;
- development and expansion funds.
- By the level of diversification:
- poorly diversified;
- well-diversified funds.
If we talk about the industry orientation, then 90% of venture capital goes to the development of the information technology sector. And if state regulators acting as investors invest mostly in industry, energy, medicine, biotechnology and construction, then private funds are focused on promoting Internet business.
Advantages and disadvantages of venture investment
For those who are still willing to take a risk, it is simply necessary to analyze all the pros and cons of venture investments.
The advantages of the latter experts include the following:
- high profitability, which in case of investing in successful projects can reach 100%;
- the opportunity to create a financial reserve for the future;
- reliability and safety of investments, which is achieved through a multi-stage analysis procedure, well-coordinated work of professionals and strict control over the progress of projects;
- risk reduction due to diversification of investors and investment facilities;
- the opportunity to legally engage in high-risk investments.
Of the shortcomings , experts note:
- big risks despite a set of measures to reduce them;
- high entry threshold for private investors;
- cost-effectiveness, which implies the payment of commission to managers, as well as the need for long-term investment of large amounts;
- inability to participate directly in the process. An ordinary investor is assigned the role of a passive participant who cannot independently choose projects and manage them.
Stages of venture investment
Due to its specificity, venture investment obeys a certain pattern, which assumes a gradual movement towards the final goal:
- The sowing stage.
Its essence boils down to the creation of a business plan and financial justification. The goal of the initial stage is to interest a potential investor. The costs are minimal, and often the entrepreneur spends his own funds.
- Early stage or startup stage.
At this stage, serious financial injections are already required due to which the initial product is being created, pilot tests are being conducted, and various organizational processes are being launched: company creation, documentary support, team recruitment, management composition determination, etc.
- Expansion stage (middle stage).
The development of the company is in full swing on it, the necessary areas, equipment, raw materials are purchased and mass production begins.
- Late stage.
At a late stage, the company has a working business model, a sales market and growing profits. A successful project pays off completely and shows consistently positive results for several months or years.
- The final stage.
His goal is to make the company public by placing its shares on the stock market. At the final stage, investors leave the project, receiving their profits. At the same time, it is important to catch the right exit moment when the growth rate starts to slow down. The value of the company’s shares at this stage significantly exceeds the initial cost of the controlling stake, and the difference is the main profit of the fund.
How to become venture investors
There are several ways to participate in the development of promising projects. So, some investors, having reached the ceiling in their business career, are independently searching for startups. Others do it with the help of crowdfunding, that is, on international and Russian platforms for venture investors. Still others join investor clubs, whose members are engaged in joint investments in various projects. And finally, those investors who have significant capital turn to venture funds.
And here it is important to understand that startup shares are not an asset that can be sold on the stock exchange and earn on the difference. Venture investment involves a long-term investment of funds and the receipt or lack of profit in the future. No one will give guarantees, and even independent project management in the role of a business angel (private venture investor) does not guarantee that the company will enter the stock market. In the best case, the investor will be able to sell his shares to another investor and compensate for the costs a little, in the worst case, if the project does not develop, he will lose his investments.
Concluding the topic of venture investment, we will designate the top in the rating of the most successful venture investors. The top ten according to Forbes includes: Jim Breuer, Marc Andreessen, Peter Thiel, Douglas Leon, Reed Hoffman, Jeremy Levine, Jim Getz, Scott Sandell, Peter Fenton, David Seltzer.
Published: 18 May, 2022
