What are venture investments, what are their pros and cons

Evaluating an investment in a startup is a little more complex than deciding whether to invest in an established company that has been around for many years. However, the gamble is worth the candle: by investing in a project that has just entered the market, an investor can count on higher returns in the future.

According to Bloomberg, last year in the United States, venture capital investments in startups broke another record, amounting to $67 billion. In addition, this industry is “democratizing” every year: more and more information is available on the Internet, special platforms are appearing to help novice investors, so Nowadays, startups are not only carried out by a narrow circle of large players.

What investments are called venture?

Their name comes from the English word venture, which means “risky undertaking.”
And this characterizes the subject of conversation well. Venture investments are investments in a start-up business or startup, from which it is unclear what will grow and whether it will grow in principle. But behind the risk lies great opportunity. You are investing in a completely young business, which sometimes attracts money even at the idea stage, so there is a high risk that it will fail. But if a miracle happens, you will become a co-owner of the new Apple or Yandex.

Igor Fainman

expert in personal finance and investment management

Neither banks nor leasing companies are ready to finance a startup, and most often beginning entrepreneurs do not have collateral. Therefore, they are forced to borrow money from venture capitalists in exchange for a stake in the business.

If successful, your part received for the investment can be sold at a great profit. Notable examples of venture capital firms include Zoom, Uber, and Airbnb. The cost of the latter, for example, has increased 14 thousand times since 2008.

Cooperation with business angels

Under the poetic name lies a new type of investor. These are individuals who invest in startups, helping them develop and enter the market. Like venture funds, they prefer to sell a stake in an established company and earn a good profit from this.

They act independently or team up with other investors to participate in projects. This is the most closed group of private investors who offer investments ranging from $50 thousand to $1 million.

The main differences between business angels and venture funds:

Invest only their own (personal) funds. Many mutual investment funds manage investors’ finances, and therefore do not want to take risks and cooperate with unpromising business projects.
They invest professionally, so they cooperate with newcomers in business and are not afraid to delve into new areas of activity.
They make decisions more flexibly, guided not only by “bare” calculations, but also by their own experience. They become more involved in a business project, passing on their skills and knowledge to budding entrepreneurs.

Famous entrepreneurs and former top managers of reputable companies act as business angels. They try to invest savings or free funds in innovation, understanding their full prospects in the future. Among the famous foreign investments are expensive brands Yahoo!, Alibaba, Intel and Biogen.

What are the advantages of venture investments?

High profitability

If the project you invested in takes off, it’s like hitting the jackpot in the lottery. Remember Airbnb, which was already discussed. Or here’s another example: the corporate messenger Slack. Now the company is valued at Slack 18 billion dollars, and in March 2010 it approached investors with a modest value of 23.5 million.

Potential returns can exceed 1,000% of invested funds. And already within the first few years.

Igor Fainman

Low entry threshold (with nuances)

According to the expert, you can start investing with small amounts. But it depends on the method you choose to get into venture investing. To get started, 100, 50 or even 30 thousand rubles may be enough. We'll talk about the available options below.

Participation in something great

If the company breaks into the top, you can be proud of your financial acumen and the fact that you considered the brilliant idea of the project creators at an early stage.

Features of startup financing

The most “tidbit” for any investor is innovative projects. Investing in startups can bring huge profits and exposure to a business angel or venture capital fund. Having invested $100,000 in Amazon, entrepreneur Thomas Ahlberg received $26 million from the resale of the brand's share.

There are several ways to find an investor for your promising startup:

Join special business incubators for beginners . These organizations, for a certain percentage of the share of the future enterprise, are ready to offer office space, assistance from lawyers and economists, training in the basics of entrepreneurship and close cooperation;
Use personal acquaintances and connections. The method is ineffective for young talents who are just entering the market. Here, family members are more likely to act as investors;
Participate in special annual competitions or forums . For example, the youth congress on Seliger annually attracts thousands of innovators and investors from all over the country, and is encouraged by the Russian government at the highest level.
Post data on exchanges or platforms for startups . In Russia, online platforms inproex.ru and startup.ua are popular. They represent an extensive base, helping companies interested in investment to start working together.

To quickly find an investor and launch a startup on the market, it is better for a team of entrepreneurs to use all available search options. Innovations in the field of medicine, online sales, Internet technologies and applications for gadgets are most in demand. More and more foundations are interested in educational programs for different ages and “green” environmental developments.

What are the disadvantages of venture investments?

High risk

The investment rule works 100% here: the higher the potential return, the greater the risks. The future of the startup is unclear, and the likelihood that it will fail is high.

The company has no obligations to you, and bankruptcy is a normal routine process. When investing in a venture project, be prepared to part with the money invested.

Igor Fainman

The need to play for a long time

Of course, it happens that you invested in a project and it quickly gained momentum - take it and sell your share. But it won’t happen tomorrow anyway. In addition, if you hurry, you can make things cheaper: development and price increases are a long-term story.

Danger of Fraud

According to Igor Fainman, this is a fairly common occurrence in the world of venture capital investments. For example, financial pyramids can operate under this cover. And if you run into one, the money is guaranteed to be stolen. Therefore, you need to very carefully study the projects you plan to deal with.

Content

What is venture investment
Types of venture investments
Pros and cons of venture investing
Features of startup financing
Sources of financing
How a venture fund works
Popular venture funds in Russia
Cooperation with business angels
Step-by-step instructions for venture investing

The word “venture” can be literally translated from English as “risky business”. This perfectly reflects the meaning of such investments. They can bring either complete collapse or huge profits, which will more than cover all possible shortcomings of the project.

Having appeared in our country relatively recently, venture investment has already contributed to the development and successful establishment of some companies, Rolsen, the gaming holding Astrum or the KupiVIP sales club.

How to start investing

There are several ways to enter a start-up business or startup through venture capital investments.

Through IPO

This is the first public sale of the company's shares (IPO - Initial Public Offering). As a rule, by this point it has already gone some way, and investors can evaluate what they are investing in.

After an IPO, the company becomes public and reports on its activities in accordance with all the rules. Accordingly, the investor buys shares, investing his capital in business development, and hopes that the securities will rise in price.

Directly before IPO

You can get involved in a project directly at an early stage - become a so-called business angel. Of course, for this you need to have large sums: 10 thousand rubles will not raise the company.

Through a venture fund

This is an organization that is focused on working with startups and innovative projects. The fund collects money from several investors and then divides it among potentially successful projects.

This is the right strategy: if nine startups out of ten fail and one succeeds, the profit can allow you to cover losses and go into profit. Actually, this is the meaning of venture investments.

At the same time, the organization’s specialists analyze the potential success of projects. This is important, since funds often enter into a project in the early stages, when the business as such does not yet exist.

Ideally, if the strategy works, the fund divides the profits among investors according to their shares. However, Igor Fainman notes that the risk when investing money through a venture fund is quite high, since its expertise may be insufficient. Therefore, it is worth paying attention to the fund’s reputation.

Through crowdfunding platforms

On these sites, companies raise money for their projects, offering some kind of reward for investments. Usually we are talking about goods or gifts. But sometimes sponsors are also promised a share in the company.

Through investor clubs

They can be different, but in general the point of such an organization is to select projects suitable for the investor, supervise transactions and receive interest for this. At the same time, clubs provide the opportunity to participate in syndicated transactions, when several investors come together. Their role here is more active than in venture funds.

Typically, investor clubs look for startups in the early stages, which entails high risks. There is another nuance.

Often scammers disguise themselves as a club and sell there not real projects, but air. You need to be as careful as possible.

Igor Fainman

Specifics

As with any other investment methods, venture investments have their own specifics:

Investments occur at the opening of the project, at the stage of formation of the authorized capital. Often some percentage of the funds is deposited before the company is registered. At this point, the investor has only studied the business plan because there is no way to evaluate practical profitability.
The creators of a startup project have no guarantees for the investor. In case of unfortunate circumstances, it is impossible to return the funds. This requires careful selection of projects. It is advisable that the investor understands the specifics of the proposed activities of the company.
By sponsoring a venture project, the investor acquires its share - this is subject to the terms of a separate agreement. If a profit is made, the co-owner has the right to count on some part of it. This part is not always commensurate with the investment. There are cases when the creator of the project does not invest anything or invests a very small share. But the investor cannot count on more than 50% participation. In modern society, it is customary that only the idea of creation comes from the author of a startup, and the funds come from investors’ investments.
Venture investing undoubtedly offers very tangible returns. There have been cases when really smart ideas for starting a business increased the investor’s wealth several times over in a fairly short period of time. Although the risk of losing funds is great, the percentage of profit is also a very tempting prospect. At the same time, even one successful investment can compensate for many unsuccessful investments.
The investor must understand that, if he has good experience in a similar business, he has a high chance of taking part in the development of a new project, and can also act as an informal consultant. This shows that the relationship between the author and the sponsor, in most cases, lies beyond the framework defined by the contract. An investor can submit an idea and take part in management - this can be very effective.
It is often necessary to support a new business with investments after it has been opened. Then the author can take out a loan, no matter whether it is interest-free or has some interest. But it must be returned within the prescribed period and in full. At the same time, the creditor must understand that the owner of the venture project will be liable in amounts not exceeding the authorized capital. And if it is less than the amount of debt, then the investor will go into the red.
Unlike classical investing, the sponsor is not faced with the task of purchasing a controlling stake. Everything is simpler here - you invested money and then received a good profit. Whether the investor will officially participate in the management of the project is specified in the contract. The right to make important decisions is indicated there. But, nevertheless, the principle of venture investment corresponds to joint actions when starting a business.
The first years, most likely, will not bring any special dividends. This takes into account long-term cooperation - that is, the direction of profit for the development of the project. Income is shared only when the business strengthens its position in the market. But there are rare exceptions to all rules.

Where to look for projects for venture investment

If you decide to act on your own, but have not yet made a name for yourself as an investor, to whom projects themselves line up, here’s what you should pay attention to:

Startup competitions - this way you will not only learn about projects, but also be able to immediately assess their potential based on the jury’s conclusions.
Accelerators and business incubators - they help young businessmen, and you can help them too.
Social networks - networking can work very well here, because you can get more information from another PR specialist leading several startups than from other open sources.
Profile media - and not only for reading publications; for example, Rusbase has a database of startups that are looking for investment.

In general, it is better to be open to different ways of obtaining information and look for projects to invest in from various sources.

Phases of venture capital investment

Implementing a strategy for such investments requires dividing the entire process into separate phases, which are discussed in advance.

It's worth considering them:

Pre-sowing. The investor must provide a relatively small cash injection to conduct market research. This is done in order to economically justify the product or service.
Sowing. It is necessary to study the project in detail and conduct an experimental launch.
First. This is where the investment of capital for the streaming production of goods or the provision of services begins.
Second. Investment of funds that will increase volumes and expand the business. There should also be some kind of reserve fund or reserves.
Third. In this phase, income from investments begins. You can further increase the pace of sales of goods or services, and somehow improve the entire process.
Late. You can connect an already implemented project to entering the stock markets. Large investments will be required, but the risk will be reduced to a minimum. At this time, the majority of sponsors begin to sell off assets, wanting to get serious income.

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.

What it is?

The definition of “venture” is borrowed from English and is used without translation. It literally means “risky venture.” In this case, the level of risk is assessed as very high. Private equity and venture capital investments are completely opposite concepts, despite their similarities. The first option involves investing in a well-known business, and the second - in a completely new one.

Venture investments include projects that have no analogues yet, for example, innovative technologies. The investor does not have the opportunity to assess real risks and prospects, so the likelihood of losing invested funds is high. At the inception stage, mobile communications, computer technology, and railways were also included in the described concept. Now this is a standard business, since the features and risks of venture investment are difficult to assess due to the lack of similar examples.

You can spend enormous amounts of money in this area, but remain without profit.

A certain well-known or new company creates a project, attracting investors. For the financial support provided, investors receive shares or an ownership interest.

Investors receive income in two ways:

in the form of stable income as co-owners;
from resale of securities.

In the first case, an average measured profit is guaranteed over a long period, and in the second - a large, but one-time profit. Venture investing is a dangerous business, so the chances of being left without profits and invested funds are high.

Terminology

A venture fund is a pool of capital for investing in private companies (startups).

Management fee, Management Fee , is the remuneration that the managing partner or management company receives, regardless of the success of the fund. It is usually determined as a percentage of the total investment obligations of investors.

Success Fee, Carry, Carried Interest or Carry is the remuneration that the managing partner receives depending on the fund's success rates. It is usually determined as a percentage of the difference between the funds invested and the return on investment. In a venture fund's LPA, this remuneration may not be specifically defined, but may be disclosed as part of the general provisions regarding the distribution of the fund's profits.

A request for the provision of capital or Capital Call is a requirement of the managing partner to the fund investors to provide financing within the framework of the investment obligations that the fund investors have assumed on the basis of accession agreements.

Investor, partner with limited rights, Limited Partner or LP – investor of the fund. The rights and obligations of the investor are formulated in the LPA, to which the investor joins on the basis of an accession agreement.

Investors' investment commitments or Capital Commitments are the total amount of financing that an investor must provide at the request of a fund. Typically, the investor does not provide all funds at once, but must do so within a certain period at the request of the managing partner.

Advisory Board, Advisory Committee is a special body that is sometimes created within the corporate governance structure of a venture fund. The Advisory Board has powers that are expressly provided for in the LPA.

Partnership is an organizational and legal form in which the fund itself is created, which unites the financial capital of investors. Also often referred to as simply "the fund".

Principals or sponsors are the key individuals who launch the fund and raise money from investors with their name.

A limited partnership agreement, Limited Partnership Agreement or LPA is the main document of a venture fund that governs the relationship between the managing partner and investors.

Agreement on the provision of investment services, Investment Management Agreement or IMA - an agreement between the fund and the management company.

Accession Agreement or Subscription Document is a document on the basis of which the investor joins the LPA and acquires the corresponding rights and obligations.

A management company or management company is a company in the form of an LLC, the participants of which are the principals. The management company provides investment management services to the fund on the basis of the IMA, receiving for this a fee for success or carry (see below).

A managing partner, General Partner, or GP is a separate legal entity, usually in the form of an LLC. The shareholders of the GP are the principals. GP gets carry.

LLC – Limited Liability Company; in this organizational and legal form a management company and a managing partner are created.

Flaws

Virtually all venture capital investments are startups. According to statistics, only 1 out of 10 projects becomes successful and makes a profit. Thus, the risks of such investments are very high. But the described feature is not the only disadvantage.

There are other disadvantages to such investments:

the organization that created the startup may unknowingly or intentionally fail to warn about existing risks;
the signed agreement often understates the investor’s income;
the possibility of facing high taxes.

You can get shares in a serious mid-income business by spending $10,000 or more.

In addition, many companies seek to avoid taxes by breaking the law, which ultimately leads to legal liability. In the described case, even a successful project will most likely be closed, and investors will be left without their invested funds.

The threshold for entering the project is minimal, but small venture investments in startups usually do not bring significant income

Advantages

The described investment option offers a set of advantages:

high level of income;
quick time to profit;
absence of legal and legal problems;
the opportunity to obtain a constant source of dividends;
simple attachment system.

If the organization that received the funds violates the law, the investor is not responsible for the actions taken. This feature makes venture investments a legally safe way of investing.

If the project is successfully implemented, the assets increase in value, providing profit to the investor

How to distinguish a startup from a small business

The term "startup" is often misused. Some people call this any new business, others understand a startup as a new Internet project. There is actually a very significant difference.

A startup is a temporary form of organization. A startup is always looking for a repeatable and scalable business model. The idea is developed from scratch, and the main goal of the startup is to find sources of profit.

A business or company is a permanent organization. It uses a scalable business model that can be replicated. At the same time, the method of earning money and the method of its implementation are initially known.

It turns out that the main difference is that companies use a ready-made business model, while startups are just looking for one.

Imagine that you are opening a new restaurant. You know in advance what your business model will look like: attracting a client - ordering - receiving payment. No innovations in terms of customer service are expected. Possible growth consists of increasing the number of customers and expanding the restaurant. In fact, this is business as usual, albeit new.
For comparison, let's give an example of a restaurant startup. It's a franchise. Another 11 years later, the brothers sold their rights to Fred Turner, who organized the McDonald's System, Inc. Today the company has more than 36,000 restaurants in more than 100 countries. McDonald's found an innovative restaurant franchising idea that had not been tried before. It made it possible to scale the business with the ability to repeat the business model.

A startup is often associated with technology, invention and technical innovation. In fact, such a project can be organized in absolutely any field of activity (for example, the aforementioned McDonald's). The name “startup” itself comes from the English “start up”, which means “to launch” and implies the beginning of the process. It is not necessary that the project be associated with any innovations. The main characteristic of startup companies is their focus on new business models and rapid growth.

Social network Facebook is one of the most famous startups. The project was originally created as an internal Facemash network for students at Harvard University, where student photos could be rated. After a scandal with illegal use of photos, the project was closed and later transformed into the Thefacebook platform, available only to Harvard. Here you could upload a photo, share your interests and connect with other people.
After attracting significant investment, the platform was improved, renamed Facebook and opened up to college and high school students. Rapid audience growth and additional investment have led to global access being opened to all users. The payback of the project was ensured by attracting advertisers. Thus, through constant research, a successful business model was found that allowed Facebook to achieve rapid growth.

Let's summarize. What distinguishes a startup from a regular business:

Novelty of the project . As a rule, a startup company is a newcomer to the market, sometimes even without a registered organizational form.
Minimum start-up costs . Often, startup companies do not have their own capital and develop through third-party investments.
Unique business idea . The basis of a startup is an idea that has not been used before and which opens up a new source of utility for customers.
Fast growth . The startup is developing rapidly, choosing the most effective promotion strategy in the market.

Types of venture funds

Due to innovation, diversification and high profitability, venture investments are a popular financial instrument all over the world, including in Russia.

By portfolio size

Large: from $150 million.
Medium: $50-150 million.
Small: up to $50 million.

By source of capital

Public and private-public.
Corporate.

By investment direction

Investing primarily in foreign startups/innovative projects.
Investing primarily in Russian startups/innovative projects.

By industry focus

Universal funds operating in different areas.
Highly specialized real sector funds.
Highly specialized information technology funds.

By geographical coverage

Small funds represented in one or several regions.
Large companies with a wide branch network and representative offices in most regions of the country.

By the degree of diversification of investor portfolios and assets

Poorly diversified funds.
Well diversified funds.

By investment stage

Development and expansion funds, mezzanine funds.
Pre-sowing, sowing and starting.

It should be noted that the Russian venture investment market has its own characteristics:

the market share of funds with state participation is about 30%, but more than 90% of investments are in the Central Federal District;
up to 90% of investments are directed to the information technology sector (mainly private funds);
Only 10% of organizations are sowing.

The above statistics indicate a certain “skew” in the venture investment market in Russia. Private funds mainly support only Internet businesses, so the state venture fund remains the only source of investment in other industries: medicine, biotechnology, industry, construction and energy.

And this is not surprising: now in Russia there is a rapid transition to a Hi-Tech economy, which has become a global trend and even a necessity. The development of advanced technologies has a positive effect on expanding the country’s market potential and its share in the global economic market. And the most important role in this process is played by venture investment, which is one of the main sources of financing innovation.

Concept

The term “venture fund” refers to companies or organizations that finance potentially risky but profitable projects.

As an investment object, venture funds choose projects of any type - the scope of the business is not of paramount importance. It doesn’t matter the state of the project: those that are at the initial stage of development can receive funding.

The main condition for financing is that projects must be unique.

However, the chosen direction should potentially bring super profits.

What types of startups are there?

Based on knowledge intensity, two types of startups can be distinguished:

Classic projects. The basis is simple ideas, processed and embodied in a different form. For example, a well-known product is modified and its functionality is expanded.
Innovative projects. Useful new discoveries are taken as a basis. A lot of money needs to be invested in such projects at the initial stage - the idea needs to be refined and implemented.

New projects can be classified according to sales markets and some product features.

Main startup options:

"Lucky copy" . These are successful projects that replicate the work of foreign startups. Borrowed ideas are supplemented with details taking into account the interests and needs of the target audience.

An example of copycat startups is social networks. For example, the social network VKontakte. It is created according to the same type as Facebook. The idea of creating VKontakte came to Pavel Durov after a conversation with his school friend and future investor Vyacheslav Mirilashvili, who became acquainted with Facebook while studying in the USA.

"Aggressive Alien" . Startups of this type try to conquer the market and squeeze out competitors due to attractive product properties or a more favorable price.

An example of an aggressive startup is the Biglion discount service. When the company appeared on the market, it had to compete with the “shark” of the coupon business - Groupon. Biglion have conquered the market with periodic discounts of up to 90%.

"A dark horse" . These are projects with a vague prospect for future development. For such startups, it is difficult to calculate the potential profit, which creates certain risks for creators and investors.

For example - Airbnb. Two friends decided to earn money to pay for the apartment. They offered those who wished to spend the night in the attic of their house on air mattresses. When the guys realized that the idea was in demand, they decided to open a company and attract investors. None of the 15 people agreed. The founders of the new company continued their work, gradually they managed to find investors and become the largest short-term housing booking service.

How to create a startup

No two successful startup stories are the same. Each new project has its own path. However, in general terms, the process of launching a startup looks like this:

Identify the problem. Determine the need of the audience that your product will fill.
Research the market. Find out if people really need your solution and see if there is a similar solution to the problem on the market.
Create a solution. Come up with a solution to the problem using innovative technologies or a new approach to organizing business processes.
Organize a team. Look for like-minded people who will be inspired by your idea and will be ready to implement it together.
Look for a way to implement it. At this stage, they test the demand for the product in the market, present the idea to investors and develop a business model that will ensure rapid and stable growth of the project.

When creating a startup, you should not expect overnight success. Before the idea begins to make a profit, the project will encounter difficulties more than once.

Statistically, 90% of startups fail. Main reasons:

Ineffective management of raised funds. For example, the company uses investments poorly or attracts too many investors who will demand returns over time.
Legal problems. This may be improper registration of activities or violation of certain laws during the production of the product.
Inability to stand up to competitors. The company hopes so much for the success of the product that it begins to ignore competition in the market and does not respond in a timely manner to the actions of competitors.
Bad business model. If a company has only an optimistic development path, then sooner or later it will face problems. It is important to provide options for action in case something does not go according to plan.