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What Is Venture Capital?

Venture financing is a high-risk investment in high-potential projects with a view to generating profits above the average market or that specialized funds can get. This type of financing is used in start-up and less developed or studied industries, which have the potential to break into new niches and dominate there.

Venture financing can function like an institution – a venture fund with a management, complex organization and other attributes of an investment fund, or a private – business angels. The regulation of venture companies (where it exists) provides for more lenient restrictions on permissible types of transactions and their riskiness.

In the financial world, venture capital is akin to the all-in game – capital is to go to projects with very low chances of success, but if a happy card is pulled out, the return from one project will cover the losses from all bad. 

Since venture capital is primarily a startup, it lives in the spheres that have the most such enterprises. First of all, these are fintech, IT, pharmaceuticals, and from recently – cryptocurrencies. 

Venture capital different from other types of investment?

At first glance, it’s simple – venture investors are just more risky and willing to walk the knife to get high returns. But in fact, it’s a little more complicated – venture investment has a number of characteristics that distinguish it from other types of investment:

  • Requirements to the projects  – it should be a project offering a fundamentally new solution or product. It is usually not tied to a factory, so it can easily and relatively quickly scale up and enter the wide market. Uber is the most obvious example of such a project.
  • The role of the investor in the project – usually fund does not just give money, but participates in the development of the startup, providing promotion services, forming the organizational structure and dealing with other related issues. However, ownership of the established company is not the ultimate goal – the investor simply expects to sell the shares in due time.
  • High risk and long-term ROI – a venture capital strategy is built with a 70% failure rate, the remaining 30% covers all losses.To maximize profits, it is necessary to sell a share  after its done and expansion on market, so money is invested for 5-7 years.
  • High threshold – to invest in a venture fund need thousands and millions dollars and in some jurisdictions venture companies working only with qualified investors. Business angels invest even more.

Despite the high probability of losing investment and the added complexities, venture companies are in demand among investors. This is not surprising if you consider high ROI of venture capital. According to CambridgeAssociates, as of the Q3 2020, the return on venture capital is about 3% more than the yield of the S&P 500 index, and at the earliest stage, the return increases to almost 60%:

Benefits and limitations of venture investment?

The above features of venture financing make it easy to identify the weaknesses and strengths of such an investment strategy. Among the main advantages of venture investing:

  • High income – is what attracts investors with experience and unskilled investors. We quote rates of venture ROI above.
  • Large opportunities – venture funds have almost no limit in their choice of investment and available transactions, allowing them to invest in niches where there are no ETF or mutual funds. 
  • The opportunity to get involved in the work of the project – primarily business angels, who often become part of the startup themselves. The regular venture fund investors are generally not involved in the project.

We should not forget the shortcomings of venture capital financing, which affect not only investors but also projects:

  • Participation requirements – the status of a qualified investor and a capital of many thousands dollars – are difficult requirements for an average investor and practically impossible for a beginner. 
  • Active participation in start-up activities – first, the development of the project may require efforts on the part of the investor, which is not the case for investment as a passive source of income. Second, startups are often affected by such participation and have to make concessions and give up ideas.
  • High risk – of course, over a long distance, these risks are justified, but with limited capital and the inability to invest in a few dozen startups, the statistical probability of pulling out. This feature threatens to bankrupt both business angels and small companies.

The stages of venture investment?

The above yield tab shows that ROI of venture capital investments vary by the stage at which the funds were invested. Involvement financing is divided into several key steps: 

  • Seed – is an investment in an idea and a command. They usually go to the primary organization of the work process, market research and prototype development. 
  • Start-up stage – at this stage a company can demonstrate a prototype or a working product that needs further development and marketing. This is already an investment in a concrete solution and the funds are usually spent to bring the prototype first to the working model and then to the full solution. 
  • Early stage – investment at the stage of product entry. The project is just beginning to sell, has no sustainable results and spends resources to promote the product and strengthen the market position. The risks at this stage are relatively small.
  • Expansion – the project begins to scale up, to enter new markets or to develop related/additional products. Investments at this stage are spent on marketing, opening new subsidiaries and increasing sales. Startup is becoming a major international project. 
  • Exit – at this stage a venture capitalist sells his share in the company and fixes the profit. Either another company interested in buying the project or publicly can sell the share if the company becomes public or goes on IPO.

The ROI falls proportionately as the project progresses through the stages of development – the closer it is to exit, the less can be earned. It is obvious that those who have invested in the idea or startup cose they will get the highest income. They usually get for their investment a major share of the project. Investment in the expansion phase will yield less return, although it surpasses the growth in the profitability of the stock market. 

Who are business angels?

A special kind of venture capitalist is business angels. Business angels are private investors who give money to a project at the first stages of its existence (on crops or before). A single business angel can hold a substantial stake in a company. Business angels have a number of features:

  • They invest personally – angels do not work with foundations, but give the project personal funds at their own risk. They are often co-founders of companies.
  • are involved in the work of the project – the business angel is often an expert in the branch in which the startup is founded or has the experience of building a profitable business. They give advice and organizational support to the project.
  • have a higher return – the value of a business angel’s share is usually lower than the value of a similar share for a venture fund that invests at later stages. That is, ROI is higher for business angels, although the return period is longer. 

To sum up, a business angel is something in between a philanthropist supporting a not-for-profit project, a business shark with a lot of experience in the investment sphere, and a classical investor looking for a ROI. It is difficult to assess the scope of business angels’ activities, as many remain anonymous and work without legal registration. 

What venture company specialize in the crypto?

The crypto industry is a new technology direction in which innovative products and solutions can be developed. Blockchain and other technologies contribute to the emergence of new startups and attract many venture funds interested in these startups. 

Thus, according to Cryptofundresearch at the beginning of 2021, there are over 400 venture capital funds in the cryptoindustry:

The first venture capital funds were launched in the industry 5-6 years ago during the ICO boom. The top 10 venture capital companies can be viewed on the Cryptofundresearch, add that the top 5 most popular include:

  • Pantera Capital – is one of the oldest funds in the industry. Pantera Capital has existed since 2003, but investment in cryptocurrencies and startups began as early as 2013-14, during the ICO era and the low cost of bitcoin. Pantera also has one of the highest yields.
  • Polychain Capital – was founded by former Coinbase risk manager Olaf Carlson-Wee. The Polychain received financing from Andreessen Horowitz and Sequoia Capital.
  • BlockTower Capital – is a venture crypto fund founded with the support of venture capital from Andreessen and Union Square Ventures. The creator of BlockTower is a former employee of Goldman Sachs.
  • Galaxy Digital Assets Fund – is a relatively new foundation founded by Mike Novogratz. Novogratz previously was an investment director at Fortress Investment Management.
  • The Digital Currency Group – is a company owned by Barry Silbert, which not only invests in a variety of crypto projects , but also manages Grayscale.

This is far from a full list of key venture capital funds in the industry, but most are located in the US and are governed by local securities laws, making access far more difficult for nationals and residents of other countries. Not to mention the high regulatory requirements of venture capitalists.

What is better: venture capital or ICO/IEO?

Often, investment methods such as ICO, IEO, and venture finance are put on the same footing because all of them are high risk. However, their comparison is not entirely correct, as the initial offer of coins and venture funds are quite different instruments for few reason:

  • Regulation – a venture capital, albeit a risky but legal venture, with certain rights and guarantees. Their investments and interests are legitimate. ICO, IEO operates without legal status, making its members unprotected and unable to claim due to the team’s non-fulfilment of promises.
  • Participants – a high entry threshold narrows of venture capital fund participants, usually it other investment companies or really large private investors. The restrictions for ICO, IEO lower, so participation is possible for almost any beginner investor with small capital.
  • An investition object  – ICO, IEO – is a mechanism for attracting investment to a concrete project, but when an investor transfers capital to a venture capital fund, he trusts them to manage and does not decide exactly where his investment will go. It means, the venture capitalist owns the share of the fund, not the share of the startup in which the fund is invested. 

In 2021, ICO was discredited and less used to attract investment in cryptocurrency projects due to lack of safeguards and legal prohibitions in many countries. However, for small private venture investors, IEO still remains a reliable and affordable way to invest in cryptocurrency projects through the purchase of tokens. Much more affordable than venture capital funds.

Conclusions

Venture capital is a separate type of investment that is distinguished by:

  • High risk and profitability;
  • Long term return on investment;
  • High entry threshold and investor requirements.

Venture capital investments are aimed at promising projects that have a chance of entering the international market or/or dominating their niche. Most venture capital is invested finance failed projects, but successful startups make up for the losses. 

The venture financing of projects is in several stages and the stage at which the investments are made directly influences the risks and returns on the investments. In general, venture capital investments outperform the benchmark market index S&P 500.

The cryptocurrency industry currently has over 400 venture capital funds, most of which are registered in the United States. The most notable are Pantera Capital and Digital Currency Group. However, for start-up investors with small capital, the more popular way to invest is IEO, as access to venture funds is difficult to obtain due to high participant requirements and jurisdictional constraints.

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