How to Invest in Venture Capital - SmartReads by SmartAsset

Venture capital is a segment of investing that focuses on new and emerging businesses. Investors, or venture capitalists, provide financing or other resources for startups or new businesses with the hopes for high returns.

The potential for outsized gains has historically made venture capital (VC) very attractive. A good – or lucky – venture capital investment can get an investor in on the ground floor of a Google or Facebook. But because they tend to invest in assets like private stock that are, themselves, restricted from the public market, investors need to meet the accredited net worth or income thresholds to participate. However, there are a few limited ways that retail investors can buy into this market.

Talk to a financial advisor today to build a comprehensive investment strategy.

What Is Venture Capital?

Venture capital is a form of private equity in which firms and individual investors fund emerging businesses in exchange for an ownership stake in the company, typically in the form of private stock. Ideally, the firm then makes back many times its initial investment when the business becomes successful and either launches an IPO or is purchased by a larger company. However, many venture capital investments never make it to this point, making it high-risk, high-reward.

Unlike public equity, in which anyone can invest, private equity investors often participate in the management and running of the business. It’s common for venture capital investors to set terms, help with strategy and otherwise participate in their investment. This can be valuable given how often startup companies are launched by people who know their product quite well, but may not have experience in running a business.

Many venture capital investors are organized into funds. They sell shares to raise money for investments, and generate proportional returns based on the performance of the underlying company in the same way as any other portfolio-based asset.

However, VC firms typically don’t get involved at the bare-startup stage. While the definition of “startup” has been stretched in recent years, with many companies claiming startup status into their second decade of operation, VC funds typically look for businesses that have advanced past the proof of concept stage.

Ideally, these funds look for new businesses that have proven their idea but which now need money to launch their product and operations. They are less likely to invest in a nascent business that has not yet built its product. The general succession of funding rounds for startups include seed, Series A, Series B, Series C funding and sometimes beyond that. Venture capital typically comes into play in Series A funding. may describe what round of funding a startup is on, and venture capital firms are typically involved early on.

Can You Invest in Venture Capital?

It is rare, but possible, for retail investors to access venture capital.

Most venture capital investments are restricted by law to accredited and institutional investors. This is because these funds invest in private equity stock, which is itself restricted from the public market. There are two financial criteria to meet to become an accredited investor: 1. Have a net worth of over $1 million (not including value of personal residence) and 2. an annual income of $200,000 or greater over the last two years and currently ($300,000 with a spouse).

Otherwise, it’s generally illegal for the public to give their money to a venture capital firm. Though, in recent years that has begun opening up a little bit, particularly with the 2015 passage of the Jumpstart Our Business Startups Act. The result is that some venture capital firms and businesses are available for public investors, although they are relatively rare.

A financial advisor can help you determine the best way to get exposure to high-growth opportunities.

How Do You Invest?

For retail investors, the easiest way to access venture capital is by investing in publicly traded companies that manage venture capital money. One example is the firm Hercules Capital (HTGC), a lender and funding firm that works in the VC marketplace. Another is the Blackstone Group (BX) or TPG Inc. (TPG)

In all cases, these are companies which operate in the venture capital space and which sell stock directly. This is by far the most common way for individuals to invest in venture capital because you aren’t actually investing in restricted assets. Instead you’re buying shares of stock in a publicly traded, publicly managed firm which manages those assets.

Bottom Line

Retail investors can get exposure to venture capital through some public securities, or those who meet the income and net worth thresholds can invest in venture capital as an accredited investor. It’s important to understand that investing in venture capital, even indirectly, comes with risks. The underlying assets of venture capital are high-risk startup companies with a significant rate of failure.

Startup Investment Tips

Investing in startups can be an exciting, but make sure that you are prepared for the risks involved, because this is a very speculative area.
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