Venture Capital Investing: What You Need To Know

By Mark Di Vincenzo. May 7th 2016

In the first quarter of 2012, venture capitalists invested nearly $5.8 billion in 758 deals, according to the National Venture Capital Association. And although that sounds like a lot of money, it is considerably less than what was invested in any quarter in 2011.

As a result, the $5.8 billion number concerned some economists who worry that the economy is slowing down. Those who watch the economy pay attention to what venture capitalists do – and what they don’t do. Because venture capitalists invest in companies, they help create jobs and spur economic growth by helping entrepreneurs turn ideas and advances into products and services.

In most cases, venture capitalists not only provide money but also guidance because they often have had successful careers as scientists, engineers and entrepreneurs, among many other professions. The downside of venture capital investing, of course, is the risk. If the company doesn’t make money, neither does the investor.

With that as a summary, we’ll ask and answer a series of questions that will tell you what you need to know about venture capital investing.

Who Are Venture Capitalists?

They are full-time, professional investors who specialize in funding young, innovative enterprises known as startups. They take a long-term approach to investing and many of them are hands-on, actively working with company executives who very well may have less experience in business than they do.

How Much Do Venture Capitalists Usually Invest In A Company?

The average investment is between $500,000 and $5 million.

Where Does The Money Come From?

Most of it comes from institutional investors such as pension funds, endowments, foundations and very wealthy individuals. The investors who invest in venture capital funds are referred to as limited partners while venture capitalists, who manage the money that is invested, are referred to as general partners.

How Many Venture Capital Firms Are There In The United States?

There are about 500 firms that have at least $5 million invested in companies – about half as many venture capital firms as in 2000 at the height of the tech bubble.

Why Do Companies Need Venture Capital Money?

Because they don’t have enough money in their operating budgets and they may not be able to qualify for traditional loans. It’s no shame to use venture capital money. Most successful, high-tech startups have done so.

What Do These Startups Do With The Money They Receive From Venture Capitalists?

They take advantage of business, legal and management consultations that venture capital firms can provide. They hire more employees, often with the help of hiring specialists who can help startups avoid hiring the wrong people. And they buy more space, equipment and supplies.

How Much Venture Capital Investing Occurred In 2011?

$29.1 billion – down from $105.2 billion in 2000. If the rest of 2012 goes like the first quarter, this year will see venture capital investments worth $23.2 billion.

What Types Of Companies And Industries Do Venture Capitalists Like?

Mostly young companies with great potential for growth. Venture capitalists are known for investing in computer, biotechnology and the communications industries. They also have put a lot of money in energy-related technology and industries.

From A Company’s Perspective, What Is The Downside To Accepting Venture Capital Money?

The money comes at a high cost. The venture capital firm may want one of its own in a key management position, someone who oversees the company and may have the power to overrule the founders’ decisions. The venture capital firm also will want an equity stake in the company -- sometimes more than 50 percent – and they eventually expect a big return on their investment dollar. They also usually won’t sign non-disclosure agreements.

How Is Venture Capital Investing Different From Other Investing?

Venture capital investing is synonymous with long-term investing. Venture capital firms sometimes are willing to wait as long as 10 years for a return on that investment, often until the company goes public or merges with another company. It’s also different because its leaders provide management expertise and try to build strong management teams at the companies in which they invest.

That Sounds Like Angel Investing. How Is Angel Investing Different From Venture Capital Investing?

Angel investors typically invest less than $1 million while venture capitalists typically invest more than $1 million. Angel investors tend to be part-time investors and venture capitalists are full time. And angel investors can also be hands on but usually not as much as venture capitalists.

How Risky Is Venture Capital Investing?

Very. Venture capitalists conduct a tremendous amount of research before deciding to invest in a company, but about 40 percent of the companies they invest in fail, another 40 percent make some money and 20 percent do very well.

What's The Difference Between Venture Capital And Private Equity?

Venture capital is part of the private equity asset class which includes venture capital, buyouts and mezzanine investment activity. Venture capital focuses on young companies more than the others.

The bottom line is that venture capital investing is not for everybody. If you are considering getting into the VC game, make sure that you do all of your homework.

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