All about Venture Capital: definition, advantages and investment strategies

Venture Capital (VC) is a type of private capital investment that invests in small- and medium-sized private enterprises, i.e. not listed on the stock market.

In this post we explain its main characteristics, advantages, risks, types of investment and how you can include it in your portfolio.

The companies in which investments are made are usually at an early stage of development. Generally, the investment is intended to finance the business plan designed by the founders. In exchange for this financing, the company gives them shares, thus becoming partners. This type of investment is one of the main sources of financing for startups.

Normally, less is invested than in other strategies such as Private Equity (PE). The participations are in the minority because the investment is destined to finance the business plan. Even so, GPs do get actively involved in the company's strategic decisions, with the aim of providing advice, contributing their experience and contributing to the development of the business.

It should be borne in mind that investments in this type of companies require a long-term time horizon, as they need time to mature and be able to generate the value that investors are looking for.

Once the GP considers that it has met its objectives, it will exit the company. This divestment can take place through different routes, such as going public through an IPO (initial public offering), or the purchase by other funds, for example, a specialized VC fund in more advanced stages or a PE fund, if the company is large enough. It can also be done through the repurchase of shares from the company itself or former partners (a process known as “exit”).

When investing in companies that are at a very early stage, the risk assumed is higher, however, so is the potential for profitability. For example, Facebook (Meta) is one of the largest and most important technology companies in the world, but before its success in the stock market, it also had its beginnings as a start-up that received Venture Capital investment. There were no similar models of success, so the risk was high, but no doubt the upside was even higher.

Airbnb, Spotify or Uber are examples of companies in which Venture Capital funds have also invested and which have revolutionized the hotel, music and urban transportation industries.

Investing in newly created companies with a strong innovative component enables investors to enter a very early stage of the project, so the potential for returns is much higher.

In addition, the universe of companies is very extensive, and we can find all types of projects, with different characteristics, which will help diversify investments in VC. They also provide decorrelation, which helps reduce volatility in portfolios.

Due to it being a long-term investment in private companies, it confers it a less liquid nature. However, this higher degree of illiquidity invites investors to respect their financial planning and establish regular savings. If investors need liquidity, there is the option of accessing a secondary market in which to sell their assets.

Investing in Venture Capital also enables investors to be part of the global innovation movement, contributing their bit to generate efficiencies and promote digitalisation. Thanks to your investment, aspects such as research, job creation or productivity will be fostered.

As in all investments, VC investments also entail risks, the main one being that a business may not develop as expected when investing in highly innovative or recently created companies. In addition, as in all private capital investments, there is illiquidity risk.

As part of the Venture Capital investment, we can find different types according to the stage in which the company we want to invest is. Let's highlight three:

• Seed capital: it invests early in newly created business ideas or companies. It is used when a startup is forming, and this funding usually comes from sources close to the founders. At this stage, we will find figures such as business angels, which are investors who provide funding at the initial stage and acquire the role of a mentor in exchange for a share in the future company.
• Early capital: it invests in the company's establishment (registration, website, offices, etc.) and the beginning of its activity when, even if there are sales, the company's EBITDA is negative. The capital contributed is larger than in seed capital investments.
• Late capital: it invests in a more advanced stage and can receive larger funding rounds. This phase is the prelude to receiving investment from a Private Equity fund or becoming listed through an IPO.

At Crescenta you will gain access to this type of company through funds or funds of funds. Thus, investors will be provided access to professional management.

Investing through funds involves a high degree of diversification. In addition, investors will increase their opportunities due to being able to access projects that would be otherwise very complicated individually.

Due to managing the money of many participants, the funds have greater capacity to negotiate and access opportunities that are not available to small investors. They also have more information and tools to make better decisions, and they have access to foreign markets, in which individual investors find it very difficult and costly to invest.

Funds or funds of funds? Choosing a vehicle or another will depend on your knowledge, as well as on the degree of risk or involvement in the investment you want to take on. If you are a more active type of investor, and you have an opinion on where there is a trend, a region that you think has more potential or a sector that you consider particularly attractive, funds are for you. However, if you want exposure to Venture Capital, but reduce risk and take on greater diversification, the best way to channel your investment is through funds of funds.

This content is merely indicative. This content is merely financial training offered to you by Crescenta, without the intention of giving any type of personalised investment recommendation.

It is neither any type of advertising of financial instruments nor a recommendation or purchase offer.

Author

Sofía Cisneros

Communication and content - Crescenta