This post explains what venture capital (VC) is and why people invest in VC.
Future posts will cover how VC funds are structured and how to earn venture-sized returns.
What is Venture Capital?
Venture capital (VC) is an investment asset class that invests in high-growth companies with a high risk/reward ratio. Much like private equity, VC takes an equity stake in a company and helps grow its value. Unlike private equity, VC invests in companies with few assets and little traction. With investment capital, strategic resources, and proper governance, venture capitalists set out to significantly grow the value of a private business and then exit the investment via IPO or a sale to another company.
Why invest in VC?
In 2015, venture capital in the U.S. accounted for $60B of investments across 1,400 companies. Today’s most valuable companies – Google, Facebook, Apple, Amazon, Uber – were all venture backed. The opportunity to invest in these companies before they become multi-billion dollar giants drives investors to back venture funds.
Often called innovation or risk capital, venture capital helps commercialize innovations at a time when a business is unable to get traditional financing like debt. In return for this risk, venture capital has the opportunity to earn significant returns to shareholders reaching IRRs of 20%+, especially at the early stage.
Venture capital funds mitigate this risk by investing in several companies. The combination of investing early in high-growth companies coupled with diversification improves the chances of outsized returns.
Aside from potentially large returns on investment, the venture capital asset class has one of the most sought after aspects of a proper investment portfolio: uncorrelated returns. Sophisticated institutional investors have diversified investments across several asset classes (public equities, bonds, real estate, etc.) Because these asset classes are usually connected to an economy or industry’s performance, shrewd investors are always seeking asset classes that are uncorrelated to the returns of their largest holdings. So if the public market experiences a rapid decline, asset managers are hoping to have made investments that would cover those losses. Venture capital has the potential to do just that.
In the example below, Omer Ventures – one of Canada’s largest pension funds with more than $65 billion in net assets – demonstrates how the VC asset class has uncorrelated returns to both the public and private equity markets (correlations of 0.37 and 0.02, respectively).
“As a recent anecdotal example of the lack of correlation, Apple’s world-changing iPhone was released in the midst of the 2007/2008 credit crisis. The credit crisis all but shut-down PE investment, whereas the iPhone launched the mobile web platform which has since provided for years of successful venture investment.”
This is part 1 of a 3 part series explaining how the venture capital industry works. In our future posts, we’ll cover how venture capital funding is structured and how to earn venture-sized returns.
To find out more about VC investing or to find out more about Graphene Ventures, contact us at firstname.lastname@example.org
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