What is venture investment - definition, types and methods of investment

How venture funds work and what venture investments mean in simple words. Methods of investing and earning money, Lists of funds in the USA and Russia.

A young biologist comes up with a new technology for cell reproduction, an engineer is developing a new engine, and a programmer wants to create a new messenger. What do these young people have in common?

? Two things: the presence of new promising ideas and the lack of money to implement them. Where to get the much-needed finance to bring ideas to life? An investor is required - a person or company willing to take a risk and invest their money in the development and implementation of a new product. Such an investor is ready for his money to go down the drain along with a bad idea, but if the idea takes off, the investment will not only pay off, but will bring huge profits.

Social network TikTok

(TikTok), created on the basis of a music platform developed by young Chinese
Alex Zhu
and
Liu Yang,
also developed on the basis of venture capital investments.
Now the founders have become millionaires, and the owner of TikTok, Zhang Yiming
, is on the Forbes list with a fortune of over
16 billion
. dollars.

In terms of potential earnings, direct venture investments are unrivaled. Investing in a promising company at the startup stage allows you to achieve a profitability of hundreds/thousands of percent in 5-10 years.

In 2021, the volume of venture capital exceeded $100 billion

, so this direction is popular despite the increased risk.

Investors who are willing to risk money and invest it in new startups engage in venture capital investments.

Below is an explanation of what venture funds are, a description of the essence and processes of work.

Definition of venture capital investment

Venture capital is investing in young businesses or startups. They have a high risk of losing money and profits that amount to hundreds of percent.

Investors receive equity in the form of shares rather than financial compensation. Therefore, they are much more interested in the growth and expansion of the company than in making a profit for it.

The venture investor's return is the difference between the price of purchasing shares and their subsequent sale. Money invested in ventures is called venture capital.

Venture investments have features that distinguish them from direct investments.

1. Long term. The average time to profit is 5 years. An investor can count on money only after the company's shares are listed on the stock exchange.
2. Investor's interest in the development of the project. Very often, large investors are included in the management of the company and provide it with all possible support.
3. The principle of “approved risk”. Investors know in advance that there is a very high chance of losing their funds.
4. The importance of the team . Since it is difficult to assess the degree of demand and return on investment for an innovative business, investors pay a lot of attention to the team. Often funds are issued not for a project, but for specific people. The implementation of the idea, the growth of the company and future profits depend on them.

Venture investors rarely have a controlling stake. In most cases, their share is 25-30%.

This video will help you better understand what venture investments are:

What you need

If you are still interested in becoming a venture capitalist, you are one brave soul. But the list of things you need to know doesn't end there. You should also know that experience is required. Without experience and a good reputation, you will not be able to compete with other companies.

Can you answer yes to these questions?

• Do you have an MBA? 50% of venture capitalists do this. If so, from Harvard or Stanford University? Sixty percent of venture capitalists with an MBA graduated from one of these schools.
• Do you have experience working for a reputable firm in technology, consulting, investment banking, media, or a startup?
• Do you have a strong social media presence? This is especially important on LinkedIn, where 85% of venture capitalists are present.
• Do you have experience with a particular technology? Do you understand this technology better than anyone? Will people turn to you for answers when they have questions about this technology?
• Do you follow leading venture capitalist blogs and technology news sites?
• Do you have a successful investment history?
• Are you planning to work with a partner? In this case, you will like this person more because you will likely spend more time with your business partner than with your significant other. Can you agree on financial decisions with this person?

Did you know that venture capital firms have underperformed the stock markets for over a decade, that high returns are rare, and investments are illiquid? If you're still interested in becoming a venture capitalist, keep reading.

Venture market participants

There are two actors involved in the venture investment process:

• depositor;
• company.

Sometimes they use the services of an intermediary - a venture fund. Let's take a closer look at each of the participants.

Investor

Sources of funding may include:

• venture funds;
• private investors;
• commercial and state banks;
• business accelerators;
• state governments;
• universities;
• scientific organizations.

Self-employed investors are called business angels. In order to become one, you need solid funds: the entry threshold starts from 50 thousand dollars. As a rule, business angels become full participants in the project:

• help develop a development strategy;
• engage in attracting other investors;
• use their capabilities to develop the company.

To invest through a venture fund, a person must have at least one million dollars.

Company

Venture capital is attracted to firms that are trying to introduce a new product or technology to the market.

Due to the fact that they are pioneers, it is almost impossible to draw up a business plan that is close to reality and get a bank loan.

Most funds are invested in companies in the following areas:

• IT technologies;
• healthcare;
• trade and services;
• transport;
• industry.

The distribution of companies by percentage is shown in the diagram below:

Venture fund

A venture fund is an instrument for investing in venture business. It is an organization that accepts investor funds and disposes of them at its own discretion, trying to bring maximum profit to investors.

Venture funds have their own classification and are divided into several types.

Type 1. By source of funds:

• government;
• private.

Type 2. By investment portfolio size:

• small (up to $50 million);
• medium ($50 to $150 million);
• large (from $150 million).

Type 3. By geographical coverage:

• international;
• local (invest within one country);
• regional (limited to several regions of the state).

Type 4. By investment stage:

• early;
• late.

Type 5. By industry focus:

• highly specialized;
• universal.

Type 6. By degree of diversification:

• well diversified;
• poorly diversified.

Each fund has its own management company, which is selected on a competitive basis. The management company appoints a manager. He does not invest his own funds, but only acts as an intermediary between the author of the project and investors.

For the final assessment of projects, an investment committee is created, consisting of experts in various fields. He makes decisions about the allocation of funds based on data from project managers.

Managers do:

1. Search and selection of companies. The main criteria are the ability to scale and increase turnover multiple times.
2. Analysis. It includes an assessment of the current state of the company, checking financial indicators and legal documents.

Every month, venture funds process hundreds of applications and letters with project descriptions. An approximate selection scheme is presented in the diagram below.

It can be seen that, at best, a couple of projects out of a hundred reach the investment committee, and not every one of them will receive money. If a positive decision is made, an agreement is drawn up and the funds are transferred to the company’s account.

After a company enters the stock exchange, the fund sells shares. The profit received is distributed among investors.

The fund makes money from commissions. He charges it on investors' deposits (2 to 4%) and profits (20 to 25%).

The principle of operation of a venture fund is explained in this video:

Criteria for project evaluation

In the course of his research, Ilya Strebulaev, a professor at Stanford Business School, learned from investors in corporate investment funds about the parameters that they primarily pay attention to when deciding whether to finance a particular startup.

Private venture capital investors are primarily driven by how talented and balanced the team is running the startup and the extent to which the product it has developed meets the needs of the market. In turn, analysts working in funds for large corporations look at how the project fits with the concept of the entire company and what potential benefit the company can get from it as the main criterion when making financing decisions.

Ilya Strebulaev. Screenshot: SVOD 2021.

Venture investment schemes

Scheme 1. Directly

In this case, the company and the venture investor manage without the help of the fund. The investor finds information about the project and contacts its author. After discussing the terms, the parties enter into an agreement. In this case, a whole package of documents is signed:

• protocol of disagreements on the project;
• act of accepting the transfer of results;
• investment agreement;
• protocol of disagreements under the contract.

All papers must comply with the model adopted by law. It is advisable to take a lawyer with you to review the documentation.

Disagreement protocols are important for both the investor and the founder of the company. They stipulate the conditions for terminating the contract and exiting the project.

After signing the contract, the investor can only wait. When the company has an IPO, he can sell his shares and make a profit.

Scheme 2. Through a venture fund

The investment scheme through a venture fund is as follows:

1. Investors apply for participation and deposit money into the venture fund account.
2. The Investment Committee selects worthy projects and finances them with investors' funds.
3. If the company is successful, the fund sells its shares on the stock exchange.
4. The proceeds go back to the venture fund account.
5. The management company distributes funds: it takes 20 to 25% of the profit for itself, and gives the rest to investors, depending on their share.

After completing one cycle, the company immediately begins the next.

An investor cannot independently select projects and participate in their management.

Kinds

It is impossible to classify risky investments only according to a number of small features; it is necessary to understand the details using specific examples and depending on the scale, stage of support, quantity and quality of investments.

By source of funding

• State . Capital consists of contributions from the state supporting a particular industry or direction for development (Skolkovo Foundation, development of agriculture or mobile technologies).
• Corporate – private investments of a specialized type (investments in a specific area – from IT to industry) or a universal format with a strict “regional” registration. Corporations often hold fundraisers to develop their own capabilities.
• Private – local projects supported by individual investors who dream of getting a share in a profitable startup.
• Mixed – an option using different types of financing. As an option - partly state and partly corporate.

By scale

• Regional . Projects on the territory of a certain subject of the state - city, region or municipality.
• Federal . Financial support is provided throughout the country (as an option - on the territory of the Russian Federation).
• International. The scale of action is the whole world without restrictions and division into controlled parts - cities and countries.

  

Depending on the stage at which projects are financed

• Sowing and pre-sowing . Investments at the idea or concept art stage. In some situations, after preparing a working or relatively functioning prototype or product.
• Starters . The situation before starting a business, assistance in finding a new workplace (not a garage, like Apple, but a reputable office), suppliers or employees.
• Development and expansion . The classic stage of financing, which involves assistance in launching mass production or in organizing cooperation with new clients by working out advertising campaigns.

By investment volume

• Large ones . Supporting serious startups is impossible without sufficient capital. When the cost of “entry” into the process amounts to millions and even billions of dollars, it is impossible to do without the prefix “Large Investments”.
• Average _ The amounts vary and are highly dependent on the specific area. In IT, the average “rates” are slightly higher, in production and enterprises – much lower. But, if we take certain values, then from 500 thousand dollars to 10 million.
• Small . A common option among startups who have not yet contacted sponsors and still have doubts about the product being developed. Amounts start from 2 thousand dollars and smoothly move towards average values.

Stages of venture investment

The process of investing money in innovative companies occurs gradually. The following stages of venture investment are distinguished:

1. Sowing stage ( Seed ). The company is being formed: business ideas are considered, a team is created, and prototypes of the future product are developed.
2. A newly emerging company ( Start - up ). The company officially started its work. Prototypes of the product are present, marketing research is carried out, an advertising campaign is carried out and mass production is launched.
3. Early development ( Early stage ). The production and sales of the product have been established, but there is no stable profit. The company has not yet reached the break-even point. All proceeds go back into circulation to ensure further growth.
4. Expansion . _ The company has found its niche in the market and achieved sustainable profits. Development continues: launching new production lines, conducting research and increasing working capital.
5. Intermediate ( mezzanine ). An additional stage does not always occur. In it, the company is trying to attract additional investment to improve its performance before selling shares.
6. Exit _ _ The company is preparing to sell the investor's stake to other people. As a result, the investor fixes profit.

At the initial stages (from 1 to 3), the company incurs losses. Starting from stage 4, she makes a profit. This is demonstrated by the graph below.

Each stage of development differs in terms and volumes of attracted venture capital. At the initial stages, firms do not require serious investments, so funds from business angels, venture funds, government funds and grants are sufficient. As the company expands, it needs more serious investments. The main sources of financing are banks and private equity funds.

Sources of financing

The capital managed by venture funds consists of investments:

• government organizations;
• individuals;
• banks;
• pension and other funds;
• investment companies;
• banks.

Sources of financing may also include other investors who meet the requirements of the venture fund.

Advantages and disadvantages of venture investments

For the investor

Pros:

1. High income. If the project develops successfully, the investor can recoup his investment many times over. Some ideas brought more than 1000% profit to their sponsors.
2. Possible payment of dividends. The investor has the right not to sell his share in a successful project. Then the company will pay him part of its profits in the form of dividends.
3. Participation in the development of an innovative product. By investing in a venture business, a person becomes an accomplice. If the project is successfully launched, he can proudly say that he helped create a new product.

Minuses:

1. The investment takes a long time to pay off. Investments in innovative businesses take time. It may take several years for it to gain momentum. During this time the investor will not receive any income.
2. Very big risk. According to statistics, only 1 out of 6 projects is successful. You need to be very careful when choosing a company to invest in or diversify your risks by investing your money in several businesses.
3. High entry threshold. You won't be able to start investing with $1,000 in your pocket. At the initial stage, an innovative business requires from 50 thousand dollars , and at later stages the investments amount to millions.

It is worth investing in a venture business only if you have experience. The investor must be an expert in his field and understand the product offered by the company. Otherwise, the investor will only receive losses.

For the company

Pros:

1. You can raise funds for risky projects. The bank will never approve a loan if there is no well-thought-out business plan. Venture investors are more lenient towards projects.
2. No collateral or financial security is required . To obtain a loan or credit, you will need to provide collateral: an apartment, a car or securities. Venture capital investors willingly agree to provide money in exchange for shares in the company.
3. There are no interim payments . There is no need to pay interest; the company owner can put all the funds into circulation and focus on development.
4. There is no requirement to return funds if the project fails. Venture investors take calculated risks by agreeing in advance that .

Minuses:

1. It's difficult to find investors. Not everyone will agree to invest a large amount of money in a risky project. Sometimes it takes years to find venture capital money.
2. It is necessary to allocate a share in the company. You will have to come to terms with the fact that the company will not be solely owned by the founder. The investor will be a full-fledged co-owner.
3. The investor can intervene in the project . Since the investor is a co-owner, he has the right to express his opinion about the company and its further development. Often investors put forward conditions, failure to comply with which threatens to terminate the contract.
4. The investor has the right to refuse further financing . If there is a difference of opinion with the owner of the company, the investor may stop making financial investments. This is fraught with the search for a new source of money. At the development stage, such events often lead to the collapse of the company.

Venture investments in the world

Leader in the field of venture investment - USA. More than 1,000 funds are concentrated here, the market volume exceeds 25% of the global one. Most venture capital funds are located near San Francisco.

Distribution of venture funds in the United States

The legal framework began to develop back in 1940-1950. The government strongly supports this industry and adopts special programs, such as:

• Select USA;
• StartupAmerica.

The first shows the advantages of doing business in the United States, thereby attracting foreign investors. The second supports business unions, universities and venture funds.

In addition, tax legislation guarantees investors a number of benefits:

• tax exemption when reinvesting funds;
• numerous delays;
• stepped tax system.

The US has a well-developed venture infrastructure, with many exchanges for public offerings of shares.

Features of the American venture market are investments in the early stages, support for foreign investors and a focus on innovation rather than profit.

In Europe, Great Britain holds the palm. An additional stock market was created for start-up businesses. It has simplified conditions for placing shares and allows you to attract the necessary capital investments.

France and Germany are also trying to develop the venture business: introducing tax incentives for investors, improving legislation, and improving infrastructure.

Common features of the European venture capital market are:

• financing of funds by banks;
• focus on national projects;
• active participation of insurance and pension funds.

Unfortunately, the European market still cannot recover from the 2008 crisis. The number of funds decreased from 1,600 (in 1999) to 711 (in 2011). After 2011, there has been growth in the market, but it is going too slowly.

Below is a map of European venture capital investment, highlighting the largest funds in different countries.

Difference from hedge funds

Venture capital funds differ from mutual funds and hedge funds in that they focus on a very specific type of early-stage investing. All firms receiving financing have high growth potential, are risky, and have a long investment horizon. Venture funds take a more active role in their investments, providing guidance and often holding a seat on the board of directors.

Managers construct a portfolio that resembles a diversified approach to investing. Many of these organizations make small bets on a wide range of young startups, believing that at least one of them will achieve high growth and cover all the costs of other projects. This allows the fund to reduce the risk that some investments will lose money.

Venture investing in Russia

Venture investments appeared in Russia later than in Western countries, which caused corresponding problems. The Russian venture market has both strengths and weaknesses.

Strengths include:

• activity of private investors;
• good intellectual and scientific potential;
• low competition;
• support of new business by scientific institutes;

Weaknesses are considered:

1. Sectoral disproportionality. The vast majority of startups work in the IT sector. Other sectors of the economy lag behind in terms of the number of transactions and the volume of capital investments.
2. Unfavorable foreign policy situation. Sanctions from Western countries significantly reduce the possible influx of foreign capital.
3. Lack of legislative regulation. There is not a single document in Russia that would regulate venture capital activities.
4. There are no offers from large companies. The main investors are private individuals. They cannot provide solid capital and contribute to the rapid growth of the industry.
5. Geographical disproportionality. More than 90% of venture investments occur in the central district. The remaining 10% is distributed by region.

Below is a comparative table of the foreign and Russian venture market.

The number of Russian venture funds is noticeably inferior to European and American indicators, as is the volume of funds attracted by them.

The Russian Academy of Venture Investors (RAVI) has compiled its top venture funds. It includes 8 companies.

As can be seen from the table, the investment size does not exceed $15 million. For comparison: American funds invest hundreds of millions in projects.

The following will help solve the problems of the Russian venture market:

1. Active support for the venture industry from the state. It is worth developing appropriate programs and legislation. It is advisable to study foreign experience and draw some points from it.
2. Expanding international cooperation. This will help attract foreign capital to the market. The best solution would be to turn to Indian and Chinese partners.
3. Popularization of venture business. It is necessary to provide tax benefits to investors and explain to them the advantages of risky investments.
4. Improving venture infrastructure. Development of state funds and exchanges, introduction of new technologies.

Despite all the disadvantages and problems of the Russian market, the number of innovative projects is growing year by year. Even with active government support, it is unlikely that it will be possible to catch up with the indicators of Western countries, but it is quite possible to bring the industry out of the hole.

Significance in economics

Due to the specific nature of their activities, venture funds provide a mechanism for transparent investment decision-making, thereby reducing the corruption component and the likelihood of abuse by the management of such organizations. Firms engaged in this type of activity improve the country's investment rating.

In addition, venture funds perform a number of other important functions:

1. open up new opportunities for the state to develop the high-tech industry, eliminate socio-economic stratification of regions, and activate small businesses;
2. mobilize free money belonging to individuals and legal entities;
3. ensure the most efficient distribution of capital in priority areas of the national economy and innovative projects;
4. attract a wide audience to the field of venture financing (i.e. increase the share of investors in the country’s economy).

Examples of successful companies

The list of projects that began to exist thanks to venture investments can be continued indefinitely: Google, Uber, Instagram and others. Let's get to know some of them.

Company 1. WhatsApp

The famous messenger was released thanks to funds from venture investors. The initial investment amount was $60 million. Investors recouped their money in full: the project was purchased by Facebook for 3 billion .

Company 2. Oculus

Virtual reality glasses. The company's founder, Palmer Luckey, used the crowdfunding platform kickstarter to seek investment. As a result, he attracted the attention of business angels and funds. The project, which began in a garage, was sold to Facebook for $2.4 billion.

Company 3. Alibaba

A simple Chinese teacher, Jack Ma, decided to create his own company and raised $60,000. The project took off: large banks and companies began investing in it. The Alibaba website has overtaken the famous Amazon and eBay in terms of total turnover. At its IPO in 2014, the project was valued at $168 billion.

Company 4. Snapchat

During the development stage, the messenger raised $500 million. After going public, the project was valued at 31 billion. Expected profit - 1 billion annually.

How to become a venture investor from scratch

The most important thing is to realize that venture investments involve serious risk. If you decide to engage in this type of activity, you must:

• study specialized literature;
• accumulate capital;
• select a sphere.

After this you can:

1. Become a business angel. You will have to look for projects on your own. Most often, such investors invest money in startups of friends. In Russia there is an association of business angels (NABA), joining which will help you find a use for your money.
2. Register on the crowdinvesting platform. One of the inexpensive ways. It is enough to have from 10 to 20 thousand dollars on hand. Serious investors use crowdinvesting platforms only to assess the market situation. It is almost impossible to find multi-million dollar projects there.
3. Contact a venture fund. Suitable for inexperienced and lazy investors. The management company will take on all the burdens and worries, all that remains is to sit and wait for the profit. The option is available to those who have more than $1 million.

What is a corporate venture fund

A venture fund whose only limited partner is a large corporation, and whose investments are made in the interests of this company, is called a corporate fund. In English, the abbreviation CVC is used to denote it.

Over the past few years, the number of such funds has increased from a few players in the market to thousands. At the start of 2021, there were 965 corporate venture capital funds worldwide. According to conference speaker and Stanford Business School professor Ilya Strebulaev, who conducted his own research, a third of all investments in the world come from CVCs, and the total value of their transactions is already more than $1.5 billion.

How to attract venture capital investments

It is necessary to prepare a package of documents. Without them, no investor will even consider your proposal. It includes:

1. Teaser. Brief description of the project. You will need to describe its purpose, analyze competitors and target audience. Serves for initial acquaintance of the investor with the product.

Needless to say, there are no competitors. In this case, the investor will be wary and consider the project unpromising. If there really are no competitors, then you need to “invent” them, that is, give examples of the activities of companies in a similar field.

1. Presentation. A detailed description of the project, its pros and cons. Sent to the investor after prior consent.
2. Memorandum . It sets out the evidence for the facts presented in the presentation. Goes with her.
3. Financial model. Presented in the form of graphs, tables and diagrams. The model describes the scheme for generating profit, distributing income and expenses.

The cooperation agreement is concluded after discussing all issues with the investor; there is no need to send it in advance.

It is advisable to have a well-formed team. Investors love it when:

• the author of the project has experience and understands the current situation on the market;
• employees (developers, programmers) have unique skills and extensive work experience;
• the team can create the product themselves. They don’t need marketers and designers: they can be easily replaced without visible damage to the project.

The following factors sharply reduce the likelihood of receiving investments:

• lack of patent;
• parallel work on several projects;
• team inconsistency;
• difficulty of scaling.

After preparing the documents and assessing the project, you can move on to searching for investors.

More details about fundraising are provided in the video:

Where to find a venture investor

Most often, investors are sought using:

1. Personal connections. You can contact your friends and find out if they are interested in the project. The disadvantage of this method is that it is situational (not everyone has rich friends) and the length of the process, because sometimes you have to get around more than a dozen people. Plus - investor confidence.
2. Business accelerators. These are special organizations that support innovative companies in exchange for a percentage of future profits. They help prepare documents correctly, provide accounting services, provide premises and look for investors.
3. Venture funds . You need to send a presentation of your project to the foundation’s email. It is advisable to send letters to several companies at once, since each of them has its own geographic and industry preferences. In case of a positive assessment, managers will contact you and tell you about further actions.

The funds work with startups that require serious investments (from 200 thousand dollars). They are not interested in small regional projects.

Venture investments are a financial instrument that allows you to obtain funds for business development or good income. They are an excellent alternative to loans, especially for young businesses. In Russia, venture investments are poorly developed, but the market is showing stable growth. It is possible that in a few years they will become as popular as traditional investments.

Principle of operation

The work scheme boils down to the following points:

1. Company employees find potentially attractive companies or consider an application from the project initiator (startup owner).
2. A comprehensive analysis of the project is being carried out.
3. Capital is generated for investment in the approved project.
4. Funds are invested in the project. At this stage, documents are drawn up that establish the responsibilities of the parties and the degree of participation of the management company (fund management) in the activities of the financed organization.

In the future, if necessary, the fund invests additional funds in the project at different stages of its development. For several years, management monitors the activities of the funded organization.

As soon as the profitability of the project reaches its maximum value, the venture fund sells its own share.