1. What is venture capital financing?
Venture financing is a long-term, high-risk investment in the capital of new high-tech startups (or already well-established venture capital companies). The latter are usually relatively small enterprises focused on the development and production of knowledge-intensive products.
The venture industry is most developed in the USA. This sphere is also actively developing in Europe and China.
2. How does venture capital financing differ from classical investments?
As a rule, venture financing is associated with a high risk of loss of investment in each particular company (such probability is usually more than 50%). Thus, this sphere is associated not only with growing innovative companies, but also with expectations of high profits and significant risk.
The return on invested funds usually occurs when the investor sells his share in the company. Profitability of investments is achieved at the expense of high returns on the most successful projects.
3. What are the advantages and disadvantages of venture capital financing?
For startups, the advantages of venture financing are as follows:
- The ability to raise a significant amount of capital for high-risk projects when other sources of funds are not available.
- No collateral or other security is needed to raise funds, as is the case with loans.
- Funds can be provided at short notice.
- As a rule, this type of financing does not provide for intermediate payments (interest, dividends), etc.
- The ability to raise funds not only at the initial stages, but also as the company matures and the product it creates improves (in subsequent rounds of financing).
Disadvantages for startups:
- It may be difficult to find investors and raise the amount of money as planned.
- Venture capitalists may offer financing on unfavorable conditions.
- The possibility of attracting venture financing strongly depends on the state of the market.
- The possibility of an investor unexpectedly withdrawing from the project or selling his share to third parties.
- Need for stake allocation (the use of venture capital financing may lead to a change in the distribution of ownership and loss of decision-making control).
- The industry is underdeveloped in many countries.
For investors, the main advantage of venture capital financing is the high potential profitability. The obvious disadvantages are the high risk of loss of invested funds and the relatively long investment horizon (3-7 years). In addition, venture capital investing is mostly for experienced investors who have specialized knowledge and are familiar with the project.
4. What are the stages of raising venture capital investments?
To streamline investments and reduce risks, the project financing process is usually divided into several stages, called rounds. In various cases, an investor may conduct financing using more than one round or one of the rounds. In other words, the division into rounds is a convention, and it is not necessary at all.
The seed round (seed round) – the first stage of fundraising, in which investors are often the founders of the startup, their relatives or friends. Usually the initial funds cover part of the project team’s expenses, development of a business plan and a prototype of the future product, as well as market research. As a rule, at this stage, the startup is not able to provide independent financing. Nevertheless, the product being developed by this stage may be able to solve a real customer problem.
Sometimes venture capitalists participate in a pre-seed round. This is the very first stage of investment attraction, in which the startup may only have an interesting idea among the developments.
Financing at the seed stage is the riskiest, as the investor does not yet see the final product and has only preliminary estimates of project implementation. In the USA, seed capital usually starts at a few hundred thousand dollars and does not exceed $1 million.
Round A usually implies investment in a company with an already functional product, loyal clients and clear development plans. The volume of attracted funds at this stage is much higher than the amounts received before. The startup begins to build a formal structure, enters the market, and expands.
Round B involves the scaling of the company after the achievement of predetermined targets. Often, at this stage, the startup develops new markets, expands in the occupied niche, and increases profits. The amount of financing that is raised usually starts at $1 million.
Round C company generates cash flows sufficient for self-financing. In other words, the startup becomes profitable without external support.
Round D is usually the stage preceding the IPO or the sale of the company to a strategic investor.
5. Who are business angels?
A business angel is a private venture capitalist who provides financial and expert support to companies at the early stages of development.
Historically, business angels have been the main source of external financing for new companies with rapid growth potential. They help startups get past the stage when the amount of resources required for development exceeds the capabilities of the founders. The startup gets the opportunity to expand its staff, finish the first version of its product, and attract its 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. A business angel who enters the capital of a company usually gets a seat on the board of directors and the ability to block the decisions of the founders, which he deems irrational.
6. Which venture capital firms specialize in the crypto industry?
Some of the best known venture capital firms specializing in blockchain and cryptocurrencies are Pantera Capital, Blockchain Capital, Polychain Capital, Andreessen Horowitz, Digital Currency Group, Galaxy Digital and Morgan Creek. The latter is notable for being the first in the industry to raise money from pension funds.
Pantera Capital is considered one of the most profitable venture capital firms. Last year it was announced that the company was launching a $175 million venture capital fund focused on blockchain and cryptocurrency projects. The fund is interested in late-stage startups that develop infrastructure solutions and trading platforms, among other things.
Blockchain Capital is a prominent player in the crypto industry. Last year, it raised a then-record $150 million for a fund specializing in bitcoin and blockchain startups. Partners include prominent Wall Street analyst Spencer Bogart and bitcoin developer Jimmy Song. Blockchain Capital has once invested in Coinbase, Ripple, Circle, Kraken, 0x, Xapo and Abra.
The infographic below shows the Digital Currency Group investment portfolio, whose CEO and founder is Barry Silbert, a well-known figure in the crypto industry.
Hedge fund Polychain Capital, considered one of the largest in the industry, raised $175 million earlier this year. The funds will be used to buy stakes in struggling cryptocurrency projects.
In 2018, Polychain became the first hedge fund in the cryptocurrency space with more than $1 billion in assets under management. However, large does not always mean profitable. For example, in less than a year, the value of assets held by the Polychain Capital fund sagged by a third.
7. What is more popular – venture capital financing or ICO/IEO?
The field of initial coin offerings (ICOs) is currently in deep decline. In the first quarter of 2019, for example, ICO projects raised $118 million – 58 times less than last year, when the figure was $6.9 billion.
Of the 2,500 projects whose development TokenData service has tracked since 2017, only 45% managed to raise funding. At the same time, only 15% of the tokens of successful ICOs are trading at or above their issue price.
On the other hand, initial exchange offerings (IEOs) are gaining popularity. They are an alternative version of the ICO, where the key role is played by the exchange, which is engaged in the selection of promising and viable, in its opinion, projects. IEO-projects are already carried out on the basis of many trading platforms, attracting significant funds. However, in terms of its scale, this sphere is not yet comparable to the volume of the ICO market in 2017 and early 2018.
The IEO model is not without flaws and has a number of problems. There are also no guarantees that regulators will not deal with this sphere in the near future, as in the case of ICOs.
Gradually the sphere of Security Token Offerings (STO) is developing, but this market segment is still very small.
According to Diar, in the first three quarters of 2018 alone, venture capital investments in blockchain and cryptocurrency startups totaled $3.9 billion, a 280% increase over the entire 2017 figure. The average investment in cryptocurrency startups also increased by almost $1 million, from $1.5 million in 2017 to $2.5 million at the end of last year.
Judging by the dynamics, good old venture capital financing is developing at a steadily high rate, far ahead of such innovative forms as ICO/IEO/STO. It is also worth noting that the market value of bitcoin correlates quite closely with venture capital market activity. Consequently, as the price of the first cryptocurrency recovers to its former heights, we can expect the venture capital market to continue to grow.