What is venture financing
Venture financing is a long-term high-risk investment in the capital of new high-tech start-ups (or well-established venture capital companies). The latter are, as a rule, relatively small enterprises focused on the development and production of high technology products.
The venture capital industry is most developed in the USA. Also, this area is actively developing in Europe and in China.
How is venture financing different from classic investment
Venture financing, as a rule, is associated with a high risk of loss of investment in each particular company (this probability is usually more than 50%). Thus, this area is associated not only with growing innovative companies, but also with expectations of high profits and significant risk.
The return on investment usually occurs at the time the investor sells his share in the company. The profitability of investments is achieved due to the high return on the most successful projects.
What are the advantages and disadvantages of venture financing
For startups, the benefits of venture financing are as follows:
- The ability to attract a significant amount of capital for the implementation of high-risk projects when other sources of funds are not available.
- To raise funds you do not need collateral and other types of collateral, as is the case with loans.
- Funds can be provided in a short time.
- As a rule, this type of financing does not provide for interim payments (interest, dividends), etc.
- The ability to raise funds not only in the initial stages, but also as the company grows older and the product being developed improves (during subsequent rounds of financing).
Disadvantages for startups:
- Difficulties may arise in finding investors and attracting the amount in the planned volume.
- Venture investors may offer financing on unfavorable terms.
- The ability to attract venture financing is highly dependent on market conditions.
- The likelihood of an unexpected investor exit from the project or its realization of its share to third parties.
- The need to allocate a share (the use of venture financing can lead to a change in the distribution of ownership and loss of control over decision-making).
- Weak industry development in many countries.
For investors, the main advantage of venture financing is its high potential return. Of the obvious minuses – a high risk of loss of invested funds and a relatively long investment horizon (3-7 years). In addition, venture capital investment is designed mainly for experienced investors with special knowledge and orientation in the field of project implementation.
What are the stages of attracting venture capital investments
To streamline investments and reduce risks, the project financing process is usually divided into several stages, called rounds. In various cases, the investor can finance using several rounds or one of them. In other words, rounding is a convention, and it is not necessary at all.
Sowing round (seed-round) – the first stage of raising funds, in which investors are often the founders of a startup, their relatives or friends. Typically, the initial funds cover part of the costs of the project team, developing a business plan and prototype of the future product, as well as market research. As a rule, at this stage, a startup is not able to provide self-financing. Nevertheless, the developed product at this stage may be able to solve the real problem of the client.
Sometimes venture investors participate in a pre-seed round. This is the very first stage of attracting investment, in which a start-up startup can have only an interesting idea among the developments.
Financing at the sowing stage is the most risky, since the investor does not yet see the final product and has only preliminary estimates of the project. In the USA, seed capital usually starts with several hundred thousand dollars and does not exceed $ 1 million.
Round A usually involves investing in a company with an already working product, loyal customers and clear development plans. The volume of attracted funds at this stage significantly exceeds the amounts previously received. Startup begins to build a formal structure, enters the market, expands.
Round B involves scaling up the company after reaching predetermined targets. Often, at this stage, a startup develops new sales markets, expands in a occupied niche, and increases profit margins. Volumes of attracted financing usually start from $ 1 million.
Round C, the company generates cash flows sufficient for self-financing. In other words, a startup becomes profitable, without support from outside.
Round D usually this stage precedes an IPO or sale of a company to a strategic investor.
Who are business angels
Business Angel is a private venture investor providing financial and expert support to companies in the early stages of development.
Historically, business angels have been the main source of external financing for new companies with the potential for rapid growth. They help startups overcome the stage when the amount of resources needed for development exceeds the capabilities of the founders. The startup gets the opportunity to expand the staff, finish work on the first version of the product, as well as attract the first customers.
Business angels invest in companies directly, operating with their own capital. Unlike an institutional investor, an angel can invest not only in a finished project, but also in an idea. The business angel that is part of the company’s capital usually gets a seat on the board of directors and the opportunity to block the decisions of the founders, which it considers irrational.
Which venture capital firms specialize in the crypto industry
One of the most well-known blockchain and cryptocurrency venture capital companies is Pantera Capital, Blockchain Capital, Polychain Capital, Andreessen Horowitz, Digital Currency Group, Galaxy Digital and Morgan Creek. The latter is noteworthy in that it was the first in the industry to attract funds from pension funds.
Pantera Capital is considered one of the most profitable venture capital firms. Last year it became known that the company opens a $ 175 million venture fund focused on projects from the blockchain and cryptocurrency sectors. In the fund’s field of interest are startups in the late stages of development, developing, in particular, infrastructure solutions and trading platforms.
A prominent participant in the crypto industry is Blockchain Capital. Last year, she raised a record $ 150 million at the time for a fund specializing in bitcoin and blockchain startups. The company’s partners are a well-known Wall Street analyst Spencer Bogart and bitcoin developer Jimmy Song. At one time, Blockchain Capital invested in Coinbase, Ripple, Circle, Kraken, 0x, Xapo and Abra.
The infographic below shows the investment portfolio of Digital Currency Group, CEO and founder of which is Barry Silbert, a well-known figure in the crypto industry.
The Polychain Capital hedge fund, considered one of the largest in the industry, raised $ 175 million at the beginning of this year. Funds will be used to purchase shares in cryptocurrency projects faced with problems.
In 2018, Polychain became the first cryptocurrency hedge fund with assets under its management exceeding $ 1 billion. However, a large one does not always mean profitable. So, in less than a year, the value of assets at the disposal of Polychain Capital has slipped by a third.
What is more popular – venture financing or ICO / IEO
The area of primary coin offerings (ICOs) is currently in deep decline. So, in the first quarter of 2019, ICO projects raised $ 118 million – 58 times less than last year, when this figure amounted to $ 6.9 billion.
Of the 2,500 projects whose development TokenData has been monitoring since 2017, only 45% managed to attract funding. At the same time, only 15% of tokens of successful ICOs are traded at an issue price or higher.
On the other hand, primary exchange offerings (IEOs) are gaining popularity. They are an alternative to ICO, where a key role is played by the exchange, which selects promising and viable projects in its opinion. IEO-projects are carried out on the basis of many trading platforms, attracting significant funds. However, in terms of its scope, this area is not yet comparable with the volume of the ICO market in 2017 – early 2018.
The IEO model is not without its flaws; it has a number of problems. There is also no guarantee that regulators will not engage in this area in the near future, as is the case with ICOs.
The sphere of Security Token Offerings (STO) is gradually developing, however, this segment of the market is still quite small.
According to Diar, only in the first three quarters of 2018, venture investments in blockchain and cryptocurrency startups amounted to $ 3.9 billion, which is 280% more than in 2017. The average size of investments in cryptocurrency start-ups has grown by almost $ 1 million – if in 2017 this figure was $ 1.5 million, then by the end of last year this figure was already $ 2.5 million.
Judging by the dynamics, the good old venture financing is developing steadily at a fast pace, significantly ahead of such innovative forms as ICO / IEO / STO. It is also worth noting that the market value of bitcoin is quite closely correlated with activity in the venture investment market. Consequently, with the restoration of the price of the first cryptocurrency to its former heights, we can expect continued growth of the venture capital market.