Venture capital investments are a great way to increase your capital. The average annual return rate varies from 15% to 25%, not to mention the great fun it is investing in new technologies and founders with their glowing eyes.
To interact with the world of start-ups, investors employ significantly different methods based on what is more suited to their investment needs - be it because their limitations come from limited entry capitals or due to time constraints.
To explain the different methodologies, we have compiled this handy guide to the four most common methods of venture investing and their pros and cons.
The first and most simple way to access the start-up venture ecosystem is via VC firms. VC firms are companies made to manage and increase capitals by investing in emerging technological businesses. Funds are managed by professional VC investors and have access to resources and connections that the average wealthy figure does not.
Some of the most important pros and cons of working with a VC firm include:
- Fully dedicated, expert personnel: VC firms are run by experienced investors, many of them successful ex-entrepreneurs, that are 100% dedicated to the process and the outcome. In most cases, firm executives invest in the fund themselves sharing the capital managed directly. In addition, VC firms employ the best-in-market personnel, experts in their domain and dedicated to the process full-time and more.
- Hassle-free investments: As most of the processes are handled directly by the VC firm management and employees, the investor itself goes through less hassle than if he was investing directly.
- Lesser risks: As the entry cost is higher, VC firms can roundup larger funds to participate in advanced rounds with lesser risks involved.
- Smart money: VC firms have vast connections and knowledge in the domain of their expertise; therefore, they have the ability to help their portfolio companies with networking, scaling and customers.
- Exclusive deal flow: VC firms are working day and night on developing their resources of incoming projects, resulting in quite unique deal flows – rarely available to other investors.
- High profitability. Due to all the above-mentioned plus the high diversification of the portfolio, there is a higher than average ROI achieved when compared to the rest of the market, reaching returns of upwards of 25% yearly.
- High Entry Barrier. VC firms require checks of hundreds of thousands of dollars, at least, to manage. In addition, VC firms are extremely strict with the Know Your Customer process and their investor's reputations. As such, VC firms are not for everyone to invest through.
- Low control. As most of the investment processes and decisions are delegated to the VC firm employees, the investor itself has less control over the investments that are moved forward with his capital. Also, usually, VC investors (LP’s) are not getting positions on the invested companies’ boards, giving them even less control over the invested company development.
- Low fluidity. Once the investment goes through it is difficult to withdraw its investment until the start-up undergoes an exit event – as such, invested sums are not fluid for a period of two to seven years.
How to pick a right VC for you:
We would advise on the following parameters while selecting a VC to manage your funds:
- Great historical results
- Invests in the domain of your expertise or close to it
- General Partner is involved in the fund themselves (at least 2% of the total amount)
- Good interpersonal connections with the managers
- Fair terms (e.g. 20% carry + 2% management fee or less)
Some VC firms create communities of co-investors, also-called “clubs”. Clubs members are exposed to the firm investment decisions and can join rounds together with the VC firm.
- VC firm benefits: as co-investors can invest in the projects that a VC firm has already analysed and invested in, they benefit from all the advantages VC firm can offer – like expertise, network, analysis, and negotiations power.
- Reduced risks. As a VC firm has invested in all projects themselves, they have “skin in the game”, reducing the risks for the co-investors.
- Increased control: co-investors can decide not to invest in a project where the VC firm has decided to invest.
- Paid service: Club membership comes with a recurring payment, usually involving management fees and a share in the funds earned.
- Time-consuming: Investor must review the incoming deal flow from the fund and decide if he wants to invest and how much. Always, the final word is of the co-investor.
Alternatively, individuals can decide to invest in start-ups directly with no middlemen. This requires creating your own investing system and you are solely responsible for your decisions – making it much more time consuming, but extremely rewarding if the angel investor is skilled enough.
- Increased profitability. In the hands of an experienced angel investor, a good portfolio can be a highly profitable venture, without the need to share profits with VC firms or middlemen.
- Full control: Angel investor frequently gets a seat on the Board of Directors, including voting rights; therefore, an ability to affect company decisions and growth.
- Very time consuming: All the hurdles need to be confronted by the angel investor directly, including legal and due diligence. This also includes the entirety of the negotiation of the terms, management of one’s portfolio and more.
- Increased Risks: the angel investor must deal with all potential issues himself (legal, interpersonal, financial etc) without having aggregated resources and a supporting team behind.
- Low rounds: Angel investors usually have access to initial rounds only, by default considered to be riskier and more dangerous. In addition, seed investors are more exposed to investment terms deterioration in future rounds.
For investors that have less capital to invest, crowdfunding is a viable option. It allows the investor to co-invest in smaller projects with smaller check re1quirements and can serve as a stepping stone to build one’s capital.
- Low entry point. As most crowdfunding investments involve multiple investors and the scope of the projects is smaller, the entry check can be much lower than the previous two options making it easier to join rounds.
- No need for accreditation. Due to the way the crowdfunding deals are structured, the investor does not actually need to be accredited as one – this casts a wider net on the number of investors that can participate.
- Low profitability. As the companies that elect crowdfunding to raise their capital are usually of smaller scope and with lesser growth potential than the ones in the VC or Angel sphere, the final profitability is usually lower than their counterparts.
- Low focus and expertise. Crowdfunding sources usually do not specialize in a single domain, leading to a lack of expertise. This can result in less professional due-diligence and worth of the start-ups proposed – in fact, tier 1 projects rarely crowdfund.
To sum up, we would advise on the following steps to individuals who decided to increase their capital via venture investments:
- Decide that venture investment is for you.
- Give funds to a Venture Capital firm to manage
- Co-invest with a VC firm
- Invest directly (preferably in the domain of your expertise)