How to Invest in Venture Capital

Many of you will be familiar with the concept of venture capital and the fact that it involves money being provided by investors to startups and small businesses who need capital to achieve their long-term potential and plans.

It is a high-risk form of investing and is not for the faint-hearted or for investors who can’t afford to lose the money they are speculating with but even if you are comfortable with the risks and know what you are getting into, it is not always easy for the “ordinary” investor to find a suitable venture capital opportunity.

The relationship between venture capitalists and entrepreneurs

It is worth taking a moment to explore the relationship terms that often exist between venture capitalists and the entrepreneurs who have the business idea or concept that has fueled their desire to launch a startup.

The plain facts are that many startups fail but there are always a few spectacular winners that provide the encouragement for venture capitalists and entrepreneurs to persist with their deal-making.

If you take the view that many startups are born from great ideas by people who are not always as business-minded as you would expect or hope this should allow you to take a diligent approach to any opportunity to invest that is presented to you and check the viability of the proposal and the business itself, before you invest your cash.

Venture capital trusts

Known as a VCT, this is one way to get involved in startups and growing businesses.

A VCT is a company who is publicly traded on the stock market and the purpose of each VCT is to make money by investing in other companies. A typical VCT will invest in around twenty different businesses at any one time and if you decide to invest in one of these VCTs, you will often be acquiring the service of an experienced VCT manager, who should be adept at identifying investment opportunities amongst fledgling companies which could become the stars of tomorrow.

If you invest your money into one of these VCTs you are still putting your capital at risk of course but in theory you are reducing the risk compared to if you went it alone and tried to invest directly, without the expertise or contacts that these managers have normally managed to acquire.

The general term of each VCT investment is between three and seven years, which is hoped will be sufficient time for the startup or fledgling business to have become established and profitable, allowing the VCT to sell their shares at a profit and move on to the next opportunity.

Long-term view

If you decide to invest in a VCTs, it should be with a long-term view and that means setting something like a ten-year time horizon in order to derive the full potential from your investment strategy.

The majority of VCT managers tend to be able to generate about a 5% annual return on their investments overall. They do this by structuring the loan deals with the emphasis on income generation, so the money is provided to the business in the form of a loan and shares, so that if the business fails, some of the money will have been repaid via the loan rather than it all being tied up in shares which may have little or no value when the business folds.

You should check the tax status of investing in a VCT and you may lose your potential tax relief if you sell within the first five years, which is another sound reason why you need to approach investing in a VCT as a long-term investment strategy.

Different types of VCT

There are several different types of VCT to invest in, depending on your risk-profile and preferences.

All VCTs are risky by default but some are structured in a way that the risk is more minimal than other opportunities available.

Generalist VCTs are the most popular form of investment as they invest in a broad range of companies in a number of different sectors and in companies which are at various stages of development rather than simply just startups.

There are VCTs that invest in AIM companies in the UK for example, and these are predominantly businesses with aspirations for growth that could lead to a full stock market listing.

You could also choose to invest in a VCT that focuses on a specific sector such as technology or healthcare for example and if you want a specific timeline for your investment you could choose to invest in a Limited Life VCT, which is designed to be lower risk but offers lower returns and there is a specific end date when the VCT will end and assets are then distributed to the shareholders.

Platforms

If you are looking for your own venture capital opportunities there are a number of platforms which are designed to match up entrepreneurs with venture capitalists.

To give you a flavor here are some of these sites and resources to explore:

Venture capital investments are not for everyone and you should decide whether you have a risk-profile that is suited to this type of alternative investment.

The rewards can be good but you must also expect for some failures and losses along the way, which is a reason why you can sometimes get tax relief against your investment because it is universally recognized that you might not see your money again.

If you want to get involved directly do your research and thoroughly check out the terms and the opportunity before committing any funds. Alternatively, you might decide that a better route would be to rely on the skills of a manager and invest in a VCT instead.

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Elizabeth Goldman is the editor of AlternativeInvestmentCoach.com. She has written for Investing.com, Bullbearings.com and many others.