Venture capital: the most exciting investments

YEREVAN, 22 October. /ARKA/. The rise of technology startups attracts the attention of a wide audience. The stories of young developers competing with corporations sometimes seem cinematic. An image of an innovative ultra-profitable business is being shaped, and many investors want to become part of it by forming venture capital.

How is financing of potentially breakthrough companies structured? Who is suited to this investment model? What are its advantages and disadvantages? We answer these questions in this article. 

Features of venture capital

Venture investing is investing in startups that are able to offer innovative products to the market. Most often such companies work in the field of modern technologies (artificial intelligence, genetic engineering, renewable energy).

Startup founders cannot get funds from a bank. Having essentially only intellectual property, they are not considered reliable borrowers. Therefore, the only way to develop a project is to attract investment.

Venture capital investments are associated with a special risk. Only a few out of dozens of companies succeed, so investors allocate funds to several start-ups. In this way, they avoid the risk of losing all their money and increase the chances of finding an effective project.

Investors are willing to take risks, expecting to make a profit when a large corporation absorbs a business or the company itself goes public. The ideal scenario is to invest in a startup that later turns out to be a ‘unicorn’, i.e. reaches a capitalisation of a billion dollars.

How to choose projects

Unlike established issuers, young companies do not have an established and proven business model. Accordingly, the approach to analysis should be special. 

If the company is at the start-up stage and is not yet profitable, investors do not rely on actual performance, but on an assessment of the team, the idea and its potential. Here it is important to meet the founders in person and discuss the details of the business (strategy, service, financing). 

Features of a promising project:

- Interesting product for the audience

- Optimal business model

- Unique technology that is difficult to copy

- A competent team that believes in its startup

In addition, the pre-investment value of the project should be estimated using different methods depending on the situation. If the product is already on the market, you can assess the current position of the company by analysing the work of the team at different stages: from discussion of the idea to release. This will show whether the founders are following their own principles.

Pros of venture capital investment

- If the company makes a breakthrough, the price of the securities will increase many times over. Then the shareholders can sell their share and receive a large profit that covers the costs of unsuccessful projects many times over.

- A technology business can spread quickly in different regions at relatively low cost, and additional investments help speed up the process. Thanks to scalability, venture-backed startups attract even more new customers and increase potential profits.

- Venture capitalists value not only the opportunity for material gain, but also involvement in projects that can change the world.

Cons

- Venture capital investing is considered particularly risky. Statistics show that 70% of startups fail. This is often because the product is not competitive in the market. Other reasons are poor marketing, poor management or financial difficulties.

- Supporting startups requires large amounts of capital, as you need to invest in many projects at the same time.

- Investing in startups is not the best way for beginners. In order to choose a company, you need to understand the specifics of the market in depth and distinguish between stable demand for a product and ‘fleeting’ general interest. In addition, venture capitalists often get a share in the business and the future of the company depends on their decisions.

- In the case of venture capital investment, it is particularly difficult to make forecasts. Some start-ups succeed quickly, while others need time to adapt to the market and become known. Finally, most companies will not justify their investment at all.

Who make venture capital investment

Business angels: wealthy entrepreneurs who fund early-stage technology projects.

Foundation: an organisation that pools the money of individual investors. It can be corporate. In this case, unlike an individual venture capital fund, the investors are not many individuals and companies, but one corporation.

You can buy shares yourself at the IPO stage  or act as a business angel. These are options for private investors with a lot of capital and experience.

It is not uncommon for project founders to approach status investors directly with an offer to join the business.

· There are online crowdfunding platforms at the international or local level. Here startup founders post information about themselves and raise funds. This is a good way to ‘get acquainted’ with venture capital investment and try your hand.

· With the help of platforms, you can analyse the market situation, see what big investors pay attention to, and make your own choice.

· Pros of crowdfunding:

- transactions take place online

- there is no need to pay a commission to managers, unlike funds

- companies publish reports, so investors can see where their money is being spent.

Another way to invest in a startup is to turn to an investor club. This is a community of business angels who look for startups, assess performance and choose the best options. The investor pays a commission, but it is less than in funds.

An investor club can organise a syndicate and jointly invest in one start-up. The role of manager is played by an experienced participant who selects the project and supervises the whole process. The entry threshold for a syndicate is lower than for a fund, but there are additional fees, such as legal fees and interest to the manager.

Let's highlight the main point

Venture capital investment is financing of technology start-ups capable of making a breakthrough.

Investments in startups are particularly risky and imply loss of investment in most projects. At the same time, companies that succeed make extraordinary profits.

Venture capital investment requires a large amount of capital, as funds need to be spread over several projects. As a rule, startups have to be additionally financed in the process of development.

Experienced and status investors can select companies and venture funds on their own. For beginners, it is better to choose crowdfunding platforms or consider syndicated deals.