A VC investor with money swirling around him and businesses popping up

Venture Capital Investing 101

The allure of venture investing is the gamble. It is high stakes, high reward but this career path isn’t all play. For curious entrepreneurs here is your venture capital investing 101.

In this article:

  • What is venture capital investing?
  • What is a venture capitalist?
  • VC firms and solo venture capitalists
  • 6 tips for becoming a VC investor

What Is Venture Capital Investing?

Venture capital investing involves pouring money (capital) into a business. Venture capital is equity funding in exchange for a percentage of a company’s assets. Buzzworthy startups that show promise receive financial support and mentorship for rapid growth. Venture investors will provide upper-level management, consulting, and/or technical skills to see a startup to a certain milestone.

Different Types Of Venture Capital

Venture capital is a short-term equity investment for new unlisted organizations. In the world of venture investing, you’ll come across stages of funding called venture rounds. Venture rounds are split up into 3 series called A, B, and C, with each successive round startups vie for a larger sum of money. Businesses must hit certain targets to secure venture investors for A B C funding rounds, with plans to scale the company in a 12-18 month time frame. 

Normally, venture capitalists do not support a business pre-launch. Instead, they target businesses that are commercializing ideas because they want to exit the startup with a high return on interest (ROI). After analyzing the viability of a business model they will dip into the VC fund and dispense different funding packages:

Early Stage Financing

Reserved for startups of prominent entrepreneurs, people who have a stellar track record for bringing businesses to exit. It is first-stage financing for further product enhancements and capital to drive operations. Early-stage venture capital is earned in Venture Round A.

Expansion Financing

The main objective for expansion financing is in the name—expand. Startups need capital for far-reaching effects and will seek VC funding for these growth objectives:

  1. Second-stage financing: helps begin expansion efforts, this type of investment comes in Venture Round B. 
  2. Bridge financing: short-term equity financing to help with expenses that are associated with going public (IPO). This can also be a way to bridge the gap between funding rounds if cash flow is tight.
  3. Third-stage financing aka mezzanine financing: the point is to get a company to a buyout or IPO. This investment comes in Venture Rounds B or C, and is an equity exchange for preferred stock or a convertible note due upon exit.

Acquisition or Buyout Financing

Acquisition finance enables a venture capital firm to purchase and manage a company. A buyout is when a private equity firm buys an established public company and it goes private. Venture capitalists typically don’t invest at this stage, instead, they are cashing out on previous funding rounds. If they are participating in an acquisition or buy-out, it is with a firm.

What Is A Private Equity Investment?

A private equity investment is given to private companies. Established businesses will go through management restructuring and a controlling percentage of shares will go to a holding company. Venture capital is a type of private equity investment for early and mid-stage startup financing.  However, venture capital investing has shorter holding terms than other types of private equity investments.

A character accumulating money in venture capital investing

What Is A Venture Capitalist?

Venture capitalists (VCs) are investors that provide funding to a new venture. They place a stake in companies that have promising prospects and some amount of risk. As high net worth individuals, their wealth is their asset and it is disseminated to a variety of businesses ensuring constant circular cash flow. By and large, these business qualities are what venture capitalists are seeking:

  • Measurable market and product fit
  • Owned intellectual property like patents, trademarks, etc
  • Expandable business model
  • Experienced and qualified management
  • ROI of 30-50%, within 5-10 years

Differences Between VC Investors vs Angel Investors

It is easy to confuse venture capital investors with angel investors. Here is what distinguishes a VC investor:

Angel investors focus on businesses in the initial stage of growth. Since angel investors are coming on earlier they contribute smaller amounts to a startup, compared with VC investors. Venture capitalists are more hesitant to lend to companies in their infancy. Some intriguing companies can secure VC funding, though most need to have a history of sales and a functioning business model. 

The difference in funding correlates to the non-monetary contributions from both types of investors. Angel investors tend to have a flexible involvement with companies, some are active but most are passive investors. In contrast, VC investor mentorship is fine-tuned to see a startup through the complex corporate world. Their job is to guide you through financing and operational structuring, helping a company realize maximum efficiency. 

Venture Capital Firms

It is more efficient to be a venture capitalist if you are part of a firm. Venture capitalist firms are a grouping of investors that come together to build out a larger portfolio. Most venture capital investment firms are structured as limited partnerships, with a general partner that manages the fund. Most VC firms have accreditation from the Securities and Exchange Commission (SEC) to engage in private equity investments, with financing monitored closely.

Not all investments are winners. A VC firm only needs 10-20% of its investments to have a ROI, to maintain funding reserves. Firms see the most success by concentrating energy within certain industries versus investing by the business. As well as focusing efforts on breakthrough moments for startups that have a 50/50 risk of becoming established.

Are There Solo Venture Capitalists?

Yes, if you have the wealth, it is possible but you don’t become a solo VC investor overnight. The workload of managing investments can be a challenge when flying solo. Even with extensive wealth, experience and a  heightened understanding of best practices in corporate finance is a must. That’s why your standard VC investor is grouping with other investors, to divide and conquer.

That being said, solo venture capitalists are more attractive to smaller businesses. They make swifter investment choices, deliver friendly terms and conditions, and offer more personalized services than a typical VC firm.

A solo venture capitalist skydiving over a city

6 Tips For An Aspiring VC Investor

We have 6 tips on how to become a venture capitalist.

1. Have The Means To Invest

To be a venture capitalist, you need to have money; this goes without saying. Where to get the money? It is best to pool resources early on, otherwise, you put yourself at risk to lose personal wealth and you could be legally liable if any wrongdoing occurs.

2. Create A Partnership With Other VCs

A partnership is essential in venture capitalism. Each investor contributes money, labor, or skills. One partner has to manage the fund at all times, no outside management is allowed. There are two types of partnerships a venture capitalist could set up:

Limited Partnership (LP): One investor has more say in the company than the others. This partner takes on unlimited liability, they get paid by the fund and owe self-employment taxes at the end of the year. The other investor-partners have limited liability, and provide capital for the fund as well as pay management fees to the general partner. Partners with limited liability will provide mentorship duties to startups as needed. 

Limited Liability Partnership (LLP): This is a partnership where each partner has limited liability, it is a good solution if multiple investors want to have control of investments.

3. Apply Financial Analysis To Your Investments

Financial analysis is the heart of investment strategy for a venture capitalist. You will need someone with a data-intensive analytical skill set to see the fund through success. If you have this expertise, you are well on your way to becoming a solo venture capitalist. Here is a little more about what the position entails:

What does a venture capital analyst do?

Venture capital analysts are professionals that are responsible for conducting due diligence, appraising investment opportunities, analyzing risk, and performing a myriad of admin duties. They are essential because they provide keen insight on startup risk, solvency, sustainability, and liquidity.

What is risk analysis?

Risk analysis is finding the likelihood of a business loss. VC firms will study the unpredictability of a specific course of action to determine project feasibility. Using financial tools like cash flow forecasts, income statement projections, and industry analysis they can assess the ROI of a business.

What is trend analysis?

Trend analysis helps you understand product sustainability in a potential investment. Perform this analysis by combing through sales data for patterns in: timing of sales, geographical location, demographics of the customers, etc. This will help you carve a clear marketing path to scale. 

Venture capital dealmaking in the United States reached an all-time high in 2021 at nearly $330 billion—Reuters

4. Keep Pulse On Industry Innovation

Have knowledge of which businesses are hot. If you want to become a VC investor, you need to equip yourself with adequate knowledge of the business sector, exposing yourself to new ideas and opportunities. Accelerator programs, beta testing, and crowdfunding sites are great resources for determining market viability and industry shifts.

5. Join A Venture Capital Firm

Get a behind-the-scenes look by working in a venture capital investment firm. You will have first hand knowledge on prospective startups in your field of concentration. Are you a budding investor? Get in as a venture capital associate. You’ll spend your time researching new startups and climb the ranks to partner by discovering liquid investments.

6. Reputation Is Key

You need to stand out among your competitors. Venture capitalism is built on reputation and word-of-mouth. Startups want to know that they are engaging with someone that can take them further than if they were to go on their own.  Establish a firm footprint with trusted growth methods that earn a high ROI. If you are constantly brokering bad investments and running on a loss, not only will you limit your funds, word will get out—you are the cooler.

The Venture Capital Investing 101

With the job comes risk, so make calculated judgments. Be wise, don’t put all your apples in one basket. A diverse investment portfolio protects initial fund pools and expands money to exponential heights. As a VC investor you will control hefty amounts of capital, enjoy massive autonomy, and wealth.

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