Everything You Need To Know Before Investing in a Venture Capital Investment Fund

The recent startup wave in India has made a lot of buzz around venture capital among investors and finance enthusiasts alike. While venture capital does sound like a big deal, it is quite simple to understand. In this blog, we’ll break down venture capital investment for you and equip you with key details so you can make an informed choice about experimenting with the same.

What is Venture Capital Investment Fund?

Think of a typical investment fund, but instead of investing in established stocks or securities, they exclusively cater to early-stage startups. That’s exactly what a venture capital fund is. Managed by a venture capital firm, these funds invest in startups with high earning potential. However, the risks associated with these investments are also relatively high.

Usually, venture capital investments are dominated by either institutions or high-net-worth individuals. Venture capital firms also pool a small percentage of their capital into these investments. However, they play a much more critical role being opportunistic fund managers, wherein they identify innovative and growth-oriented startups that can generate high returns for investors.

How does it work?

VC firms typically start a capital-raising period where they approach new investors to meet their funding goal. This could last from months to years, depending on the market conditions, the firm reputation and strategy. Once achieved, the fund is closed to new investors. The VC firm strategically invests the raised capital into upcoming enterprises based on thorough market research and business analysis.

This is the point where VC firms take on a fund management role, where their singular focus is to increase the profitability of their portfolio. Consequently, the firms also provide resources and support to the startups they have invested in.

All in all, the entire process takes about 7-10 years.

How are returns generated and distributed?

Unlike classic financial instruments, venture capital investment funds do not generate consistent dividends or interests. Instead, investors earn their gains at the time of exit. That is why an exit strategy is at the centre of a profitable venture investment. The three types of exit strategies are:

1. Direct share sale:

The VC fund sells its stake in the startup to another investor or the startup itself.

2. Acquisition:

As the name suggests, another larger company purchases the startup or the VC firm’s stake, buying the investment fund out.

3. Initial Public Offering (IPO):

When the startup goes public, the VC investment fund sells its stake.

What is the level of risk involved?

Investing in an early-stage startup comes with risks galore. The biggest one is that more than half of the startups fail. In this case, failures can cause the investment fund high losses that could even be absolute. Startups usually play on new technologies and unfamiliar business grounds, exponentially increasing investment risks. The earlier the stage of investment, the higher the risk involved.

How to select which fund to invest in?

Given the risks involved in these investments, it is important that one not only understands these risks, but also that the investment decision process is more rigorous to improve chances of going right with the fund selection. The parameters for selection can range from track record, team strength & experience to investment thesis, risk management, etc. Since the fund deployment is done after raising from investors, most of the evaluation is on past track record, people and process. Another important factor is that unlike mutual funds, VC investment funds are not distributed or open to all investors. Instead they tend to have exclusive tie-ups and hence, funds offered by each wealth manager may end up being different.


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