America, the land of opportunity, has been built upon entrepreneurs expanding the economic pie.  Whereas some corporation, such as Starbucks, have built empires worth billions of dollars from one original storefront, other business ideas require funding on a larger scale in order to be successful.  This is where venture capital comes into play.

Some of the major players in today’s economy have been built upon the funding seeds of venture capital.  Major powerhouses Google, Compaq, Corning Glass, and Intuit were all made possible because of venture capitalists.  In return for their funding, these bold investors pocketed a nice profit in the process. 

Venture capital fundamentals

Most venture capital firms pool together individual investors to create large amounts of money that is invested into new businesses.   Some venture capital firms specialize in specific industries, such as technology or biotech.  Each venture capital firm develops a parameter of risk tolerances and financial analysis criteria. 

Keeping an eye on the exit strategy

Most venture capital firms expect the fund to liquidate within seven years, meaning that the companies it invested in will either go public or are bought out by a larger company.  The money from the sale in either case goes back into the fund, and ideally there will be more in the fund than when the process started.  The investors then get a share of the profits depending on their initial contribution into the fund.

The inherent risks – pinnacle of the risk to reward pyramid

Inherently, the risks are significantly high for investors, and thus, venture capital investments sit close to the top of the risk to reward pyramid. 

Some of the companies will fail and declare bankruptcy, losing almost all of the investors’ money; the dot com burst is a perfect example.  Other companies may just stagnate, without any growth or productive assets.  Hopefully, some corporations will go public, which earn investors a good deal of money, while making up for the losses of other fledging corporations in the portfolio.   The success of venture capital investment rests on the firm’s ability to choose winning companies and to diversify their portfolio of companies. 

Adding venture capital investments to your portfolio

If you want to invest in venture capital, it is advisable that you already have a fully stable portfolio diversified with safe investments. It also helps if you have a lot of money. While there is potential for amazing growth in your venture capital fund, there is also a huge potential for a loss, so don’t invest your retirement or college monies here.

To find a good venture capital firm, you will need to do your homework.  Find out what types of business the firm invests in, as well as the previous track record of investments.  You can then decide if the firm’s risk profile matches your own and whether or not you are comfortable investing in them.  The value of your investment is highly dependent upon the venture capital firm’s ability to pick the successes from the minefield of losers.