Investors seeking the next Apple (ticker: APPL), Alphabet ( GOOG, GOOGL) or Netflix ( NFLX) might find it with a venture capital investment. Unlike investing in a publicly traded stock where you own a portion of a large, highly vetted firm, venture capital investments finance startups and small businesses with long term growth potential.
Most venture capital investments come from firms designed to finance startups, wealthy investors, financial institutions or investment banks. Venture capital investing is risky, with the possibility of outsized gains and losses.
Historically, only accredited investors had an opportunity to dabble in venture capital investing. An accredited investor must have a minimum $200,000 annual income, or $300,000 if married or a net worth exceeding $1 million.
In 2015, the revised Jumpstart Our Business Startups Act opened the doors for ordinary investors to participate in equity crowdfunding. With those changes, several venture capital platforms for nonaccredited investors were born.
Venture capital shouldn’t be confused with private equity investing, which typically funds larger, more established private firms.
There are many opportunities to explore and fund the next unicorn including stocks, venture capital funds, debt and equity crowdfunding platforms. But be aware that most startups fail. CB Insights’ research shows only 1% of startups become unicorns.
Here are a few common questions about investing in venture capital:
— Why invest in venture capital?
— What are the risks of venture capital investing?
— How do you invest in venture capital?
— Do you have to be an accredited investor?
Why Invest in Venture Capital?
The reason investors might invest in venture capital is to “get a front-row seat to the growth of the company and in some cases, investors get to be involved in a mentor type role with the startups’ management teams,” says Taylor Kovar, CEO at Kovar Capital in Lufkin, Texas.
Mikhail Taver, a managing partner at Gagarin Capital Partners,) believes that investing a small portion of one’s portfolio in high-risk, high-reward assets such as venture capital offers the opportunity for significant upside potential, with limited risk.
Investors must go into venture capital investing with their eyes open.
What Are the Risks of Venture Capital Investing?
Investing in publicly traded stocks and funds offer easy liquidity. When an investor wants to sell, in most cases, it’s quick to place an order and find a buyer. Not so with venture capital. There’s limited liquidity when investing in venture capital, Taver says. Investors may need to wait several years to receive their principal investment. In some cases, with failed startups, the investment return might be zero.
“The management teams of many early stage companies are not as sophisticated as later stage companies and frankly may not be as high quality as you would see in a more mature company, therefore the chances of failure are higher,” says David Hooper, chair of the law firm Barnes & Thornburg’s securities and capital markets practice group in Indianapolis.
Venture capital investment is risky and should only be undertaken with money that investors can afford to lose. In general, it’s best not to invest more than 5% of one’s investment dollars in speculative investments, experts say.
How Do You Invest in Venture Capital?
For investors ready to take the plunge into the venture capital investment waters, there are opportunities for both accredited and less affluent investors. These investments include funds, stocks, venture capital debt and direct investments.
Scott Bluestein, CEO and chief investment officer at Hercules Capital, runs a publicly traded business development company that funds innovative venture capital backed companies. The Hercules Capital fund (HTGC) offers investors the opportunity to invest in a broad swath of startups. The fund currently trades at $13.27 and offers a hefty 9.7% yield. Investors should understand that despite a high yield, long term returns aren’t guaranteed.
Another early stage startup stock is Horizon Technology Finance (HRZN). Run by CEO Rob Pomeroy this business development company makes senior secured loans to venture backed companies. The interest payments from the loans are then paid out as shareholder dividends. The stock currently trades for $11.88 and yields 10.1%.
MicroVentures crowdfunding startup platform offers investors the chance to invest in startups for as little as $100. After registering, users can peruse available investment opportunities and invest online.
SharesPost, a firm that offers private company investments for accredited investors also has an entry for nonaccredited folks. For investors wondering how to invest in a venture capital fund, SharesPost has a solution. This closed end fund gives smaller investors access to startup venture capital investing in companies like Nextdoor, Wag! and Ripple, among others. Investing in SharesPost 100 Fund offers greater liquidity than a direct venture capital investment and requires $2,500 to get started.
AngelList offers both accredited and nonaccredited investors the opportunity to invest in startups. AngelList’s funds for nonaccredited investors, currently closed, offer nonaccredited investors opportunities to invest in a startup fund. Larger accredited investors can partner with others to invest in a startup firm.
SeedInvest is another crowdfunding company for accredited and nonaccredited investors that benefited from the passage of the 2012 JOBS Act. Founded by experienced investment professionals, the company has raised over $150 million for about 150 startups. The SeedInvest venture capital market allows investors to browse offerings online and invest. Required minimum investment amounts vary based upon the company.
Do You Have to Be an Accredited Investor?
There are many online platforms for wealthy accredited investors to tap the startup market.
Forge offers a startup marketplace where investors can place trades to invest in select startups. EquityZen is a startup platform offering investment opportunities with pre-initial public offering companies. EquityZen requires accredited investors to invest a minimum of $20,000 for these pre-IPO investments.
Crowdfunder is like an online supermarket of startup companies. This crowdfunding platform lists the investment opportunities on their website and accredited investors select their investments and fund the companies.
For an accredited investor with an investment horizon of at least five to seven years and a minimum of $50,000 to devote to venture capital investing, iSelect is another startup market. Investors who create their own venture capital fund by investing as little as $5,000 in 10 or more companies to create a fund.
FundersClub promises vigorous vetting of the startups that they offer. The platform claims that it only funds between 1% and 2% of the companies that it vets. The FundersClub performance page shows the net unrealized returns of investors annually since inception in 2013.
Venture Capital investment, now widely available, is a way to add further diversification to a typical stock and bond investment portfolio. Aggressive investors, seeking to uncover a hidden gem in the startup landscape can fund entrepreneurs’ new businesses in the hope of striking it rich.
When investing in startups and venture capital opportunities, research the platform, individual small businesses, the company’s owners and understand the risks.
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