What Is Venture Capital Investing — and Should You Do It Too?

Venture investing significantly differs from all the other types of investing, not only by high risk but also by high profitability in case of success. You can invest in ten companies and return from only one. But this very return should cover your losses and provide an average return for the entire investment cycle at the level of other investment instruments, that is, about 25% per annum.

How to pick the right startups?

Bearing in mind that you get a minority stake in a startup, you need to keep in mind that a successful project must scale its market share very quickly, and ideally, its revenue, to become an interesting object for a strategic investor, after which a private investor of earlier stages can exit the project with profitability fixation.

Therefore, all venture investments, but especially of the early stages, require increased attention from an investor since he needs to recognize not only the theoretical perspectives of a startup in connection with the consumer patterns of the market but also the team’s ability to realize this potential in practice.

The team must be highly motivated, well-coordinated and competent, and the technology must be in demand by the market and well protected from copying. At the same time, it should be clear in advance at the level of a priori analysis whether the unit economy of a startup is converging.

In venture capital investments, it is not enough to look at the company’s statements for the last years and make a forecast for several years ahead to safely invest money. In the early stages, the best venture capitalists do not come out of traditional investors but former entrepreneurs.

There is another fundamental difficulty finding a good project since all early startups are not publicly available, and several similar startups are difficult to compare with each other. In other words, for a private venture investor, this is practically the second full-time independent work, and it isn't easy to combine it with your other business or your own work for hire.

You can’t really get your hands on this exciting new activity before deciding to further focus on it professionally. I’d say you don’t put all your money in a company based on your decision (which is really just an emotion).

A decision to invest in a startup not based on a decade of experience — is just an emotional impulse.

First of all, it is necessary to see what exactly gives a comprehensive idea of ​​the chances of a project to make money for an investor during the five years. Success consists of the following components:

1. a successful original business idea that attracts a wide audience of future clients,
2. a successful business model of monetizing this very idea,
3. an effective unit economy of the project, when it can make no less than 5 times more than the total cost of this operation,
4. the original technology that protects the project if it is successful from quick copying,
5. the effectiveness of a project team, which should be not only able to come up with all this or test it on test cases, but to deploy a large-scale business without losing the quality of service.

To successfully select future successful projects based on objective or subjective criteria, it is necessary to have extensive experience for formal and informal scoring of ideas, business models, the economy of people and technology.

Such people, as a rule, are former entrepreneurs or professional employees of venture capital funds, who are no smarter than any passive investors, however, and who themselves have access to a huge array of statistics on similar investments, including on the global market and daily in the information field of the market.

In other words, I would not like to recommend rushing into the whirlpool of individual venture investment to people who have not yet received such an experience both through syndicates and through investments in venture funds.

How much money do you need to invest in getting tangible benefits?

The optimal amount of money is determined in the interval between the maximum amount, which is not a pity to lose in the event of an unfavourable market situation.

For me, for example, it was always about 50% of the total capital; for novice investors, I would not recommend giving more than 10% for venture capital deals. And some the minimum amount is defined as about ten times the minimum check for investments in one project, say $ 50,000, since at least such diversification of risks is necessary as calculating one successful project for every nine failures.

That is, that’s about $ 500,000, but of course, it’s better to have a million. On the other hand, you can significantly reduce risks by syndication of transactions, that is, invest one minimum check, for example, for ten people at $ 5,000. The only thing is that the potential income will be divided among many investors, but then you can distribute funds not even for 10 projects but for all 100 projects.

Suppose that your exit comes according to preliminary plans in 5 years. Your investments should grow during all this time based on the rate of 25% per annum, and after exit, will triple at least without taking into account the planned losses on nine projects.

And to cover these losses, your winnings on a successful project should be approximately 30 times multiplied. Of course, these are authentic statistics. But here’s how to learn to recognize projects capable of such growth. This is the main difficulty here.