If most of your investments are tied up in bonds or stocks, becoming a venture capitalist is one way to diversify your investment portfolio. But jumping into it isn’t something any investor should do without understanding what it involves. If you have a substantial amount of cash available to invest, keep reading to learn more about the pros and cons of venture capitalism.
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What Is Venture Capital Investing?
Venture capitalists are investors who provide funding to startups and small companies. They can invest as individuals or as part of a VC firm. When they make an investment in a company, they’re banking on that company’s future success.
As part of the deal, the investor receives an equity share in the business. Venture capitalists make money by selling their stake in a business to someone else or waiting until a company goes public in order to generate a return. In a way, venture capitalists are like entrepreneurs because their focus is on building profitable businesses.
The Benefits of Venture Capital Investments
The most obvious advantage of venture capital investing is the potential to make a substantial amount of money. If you’ve heavily funded a startup that takes off and you’ve got a sizable chunk of equity in the company, the payoff could easily be in the six-figure range. Returns of 50% or higher are not unheard of.
Beyond the financial incentives, many venture capitalists take on these investments because they enjoy being able to help young companies gain their footing. In some cases, venture capital investors were once startup founders themselves and are leveraging their own success to help other companies grow. If you’re a wealthy investor who’s got a philanthropic side, venture capitalism might be right up your alley.
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What Are the Drawbacks?
While investing in startups can leave you with some cash, it’s also a risky endeavor. When a stock loses value, you can ride out the market to see if it’s going to rebound or sell it off and take a loss. But when a startup fails, it’s a slightly different story.
If a startup that’s backed by venture capital tanks, the investors might not be able to recover any of the funding they’ve provided. If the company has assets, they’ll first be used to pay any outstanding debts and the rest might be divided up among the investors, depending on the way that the business deal was structured. On the other hand, if a startup doesn’t have any assets when it goes under, the investors would end up with a big fat goose egg.
Even if the company that you invest in goes public, there’s no guarantee that its stock value will climb as high as you expect it to. Even if it does perform well initially, the stock could always sink later on, leaving you high and dry.
Related Article: What Is an IPO?
The Bottom Line
There’s a reason venture capitalism isn’t for everyone. Aside from needing a very large bankroll to get started, venture capitalism requires a certain degree of expertise and an understanding of how startups operate and how they fit into the larger financial market. If you’ve got the knowledge to back up your bottom line, venture capitalism could be something worth exploring.
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