What is venture capital? [And How To Invest]

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    what is venture capital

    Investing in Uber or Stripe before they were well-known companies and had publicly traded stocks could have made you a very wealthy person. The problem, however, is knowing these companies before everyone else does.

    These early-stage investments, known as venture capital, have traditionally been reserved for the rich and well-connected people. Venture capital investments help motivate private companies to go public (initial public offering). The goal of venture capital is to one day get the company public and pay off.

    While this may all seem far-fetched, the good news is that with the introduction of the JOBS Act, you don’t have to be a millionaire to invest in these early-stage companies. Read on to learn what venture capital is all about and how you can invest in it.

    What is venture capital?

    Venture Capital (VC) provides financing for private companies such as startups and small businesses. VC firms generally have millions of dollars to invest. They often come later in the investment cycle.

    Once a VC company decides to invest in a company, the investment and company are often viewed as legitimate. And that can attract other major investors and further advance a company’s valuation and resources. As investors see other credible investors step in, they don’t want to miss the boat. In this case, investment generates more investment.

    Some notable VC firms are Andreessen Horowitz, Bain Capital Ventures, and Kleiner Perkins. In the past, VC firms were mainly concentrated on Sand Hill Road in Silicon Valley. But now they’re more scattered with some of the bigger firms in New York City and Boston.

    Stages of venture capital investment

    Each injection of new money (i.e. investment) into a private business is called a streak. Series are usually identified by letters – for example Series A, Series B, etc.

    However, some investments can be made before Series A. These early stages are often referred to as seed investment rounds. Seed investments can also use different letters to denote their rounds.

    The investors involved in seed rounds and series are called Angels. These are usually the investors in the earliest stage. However, some businesses may start out with friends and family money, and an angel investor comes after that.

    The amount invested by angel investors can vary widely. Some may only invest a small amount while others invest millions of dollars, much like a VC company.

    Risks and opportunities of venture capital

    Venture capital rounds are the riskiest investments because they are so early in the company’s life cycle. Sometimes a company hasn’t even sold a product. Even if the company already has a product or service that has already proven successful, the short success stories make it difficult to assess whether this growth is sustainable.

    Take Amazon, for example. Today, the company is a huge online retailer with years of sales data and profits that investors can refer to before deciding to invest in its stock. But if you had the opportunity to become a venture capital investor at Amazon in 1995, when it was still a questionable online bookstore startup, would you have invested? How did you know Amazon was going to become? Amazon instead of the countless other online bookstores that sprang up at the end of the 90s and have long since closed?

    In addition to this inherent corporate risk, venture capital investments can also involve liquidity risk. While you can sell your shares of a publicly traded stock at any time, private equity stocks often have no secondary market. Therefore, in many cases, venture capitalists must be willing to wait months or years to get a return on their investment (if they get one at all).

    For such a high risk, venture capital investors will ask a lot. In other words, they require a higher percentage of ownership than the same amount of investment would give a stock investor if the company went public. And because of this, an angel investor can be rewarded many times their initial investment if the company is successful.

    How to invest in venture capital

    Would you like to get involved with venture capital investments? Here are three of the most common ways to get started.

    VC companies

    VC firms are also a tightly knit group but can still bring in outside investors. If you are lucky enough to be on their network, you may have the opportunity to make a great investment. But you also need to be an accredited investor.

    Angel Investor Syndicates

    Instead of investing in a VC firm, you can invest as an individual or with other angel investors. A group of angel investors is known as a “syndicate”. Instead of one angel investor putting a lot of money into investing and taking many risks, a group of angels can pool their money and split the risk.

    Some syndicates are open to the public. Others are not as well known and are more like a VC network that you need to know your way around to get into.

    List of angels – Can also invest in funds. Must be an accredited investor. The minimum investment is $ 1,000.

    Equity crowdfunding sites

    Equity crowdfunding websites are similar to syndicates that pool investor funds and then invest them in companies. Many of these websites allow investors to choose the specific company they want to invest in. It’s not uncommon for syndicates and websites to require accreditation from investors, but some don’t.

    Some crowdfunding sites allow you to invest in funds instead of investing directly in a company or through a consortium. For example, Angel List offers two different funds for investors looking to reduce some of the risks associated with investing in a single company. A fund invests in several companies and thus offers a higher chance of success.

    Some places where the public can get involved in investing in private companies are:

    • Mainvest – Invest in small brick and mortar businesses. Mainvest is open to non-accredited investors and the minimum investment volume starts at $ 100. Read our Mainvest review >>
    • republic – Invest in startups with as little as $ 10 per investment. Accreditation is not required. See our review of Republic >> here
    • CircleUp – Currently has a waiting list. Must be an accredited investor but the minimum investment is only $ 250.
    • SeedInvest – Invest in individual companies and diversify your investments with Auto Invest to up to 25 companies at the same time. You don’t have to be an accredited investor to invest, and you can start with as little as $ 500. Take a look at our SeedInvest review >>
    • EquityZen – Invest in pre-IPO companies through funds. Must be an accredited investor. The minimum investment is also quite high at $ 10,000.

    Networking

    In all fairness, the best deals are likely to come from your network, provided you are building a network of people starting businesses. Many of the first investors in large companies end up being family, friends and those in a close network.

    If you are interested in angel investing or venture capital, I highly recommend building relationships with founders and entrepreneurs. Then, when deals come about, you may be offered a chance to invest.

    Final thoughts

    While you may never be a member of a VC firm, there are more opportunities than ever for the average investor to get involved in early-stage private company investments. You will certainly take many risks. But there is also the potential for great rewards.

    We recommend that you isolate your venture capital investments (and all of your other alternative investments) to a small percentage of your total investment funds. However, if you’ve already built a well-diversified portfolio, venture capital is a high risk, high return asset that could be worth adding to the mix.

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