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Fun with Venture Capital

The Playground of High Risk Investing

By Kara Stefan

So you’ve built a conservative foundation with your investment portfolio and yearn to take on something of a more speculative nature. In the past year, you’ve probably heard a lot about the explosion of initial public offering (IPO) stock prices as they enter the market. But more recently, a new type of investment has entered the radar of mainstream investors.

Riskier and potentially even more rewarding than IPOs, venture capital (VC) is money collected from private and institutional investors and made available to provide startup businesses with exceptional growth potential.

Often the managers in charge of VC funds will partner with the new business owner to provide managerial and technical expertise. It’s basically a way to stay hands-on with their money and ensure that the business becomes a success so they get a return on their investment.

Then there are what’s called angel investors, who are more hands-off individual investors who invest in startups that are typically too small to require venture capital funding. The angel market generally seeks investments in the $50,000 to $500,000 range, and many angel investors are successful former entrepreneurs who want to help other entrepreneurs grow their businesses.

VC and the Mainstream Investor
While the VC market has come a long way towards being more accessible to the average investor, it’s still got a ways to go to be a truly affordable investment. Up until a few years ago, VC investors were expected to ante up millions just to be part of a startup deal.

But new online technologies have changed all that, streamlining operations and creating a more efficient way of bringing VC investors and entrepreneurs together. Today, you may participate in the VC market with minimum investments ranging from $25,000 to as low as $5,000.

However, while minimum participation amounts have dropped, the Securities and Exchange Commission’s (SEC) requirements have not. To become a VC investor, you must meet the SEC’s criteria of an “accredited” investor, meaning you must have either:

  • $1 million net worth, or
  • An annual income of $200,000 or more over the past two years ($300,000 for a married couple).

Sophisticated Investment
Why is the SEC so strict about who gets to invest venture capital funds? Because VC is not for the weak-hearted or inexperienced. While pre-IPO companies offer much more upside potential than publicly traded companies, their business models are not proven and they have no track record.

The SEC reports that for every 10 businesses funded by VC, 7 or 8 will fail or--at best--not turn a satisfactory profit. Research into these new startups does not come easily, either, since the SEC doesn’t require private companies to disclose the kinds of financial data that public companies must report.

VC Success Rates
Mainstream interest in venture capital has become more widespread recently, given the success of so many dot coms. Over the past two years, venture capitalists have witnessed returns of 100% or more on their investments, with turnaround times on profits as little as 18 months.

Traditionally, the VC market has averaged 20% returns (at least over the last 10 years), with the typical turnaround time closer to 5 years. Like long-term investing, VC investors must be patient and frequently have no idea how their investment is progressing.

To invest in venture capital, you really must have money to burn. You need to have a substantial investment portfolio in hand with assets left over in the kitty that you can afford to lose. That’s because venture capital investing generally requires so great a cash outlay that the average investor cannot afford to diversify by holding several different deals--the most common approach for reducing investment risk.

Where to Start
Fortunately, with the Internet, you’re already plugged into the greatest resource of VC deals and information. To further your education and explore what the VC industry has to offer, check out the following Web sites:

 

 

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