Venture capital is the lifeblood of new business development. Venture capital investors provide the start-up funds that young businesses need in order to grow, hoping to identify tomorrow's leaders early in their histories and therefore maximize the long-term return on their investment. However, financing new businesses is risky, and so the U.S. Securities and Exchange Commission imposes some limitations on ordinary investors participating in venture capital funds. Therefore, if you want to invest in venture capital, you'll need to consider the following:
- Are you an accredited investor entitled to invest directly in venture capital funds?
- Can you get access to a company through crowdfunding regulations?
- Would you prefer to invest in venture capital managers rather than their holdings?
We'll look at each of these issues below.
Accredited investors and the SEC
In order to invest in venture capital funds and other investments that don't file registration statements with the SEC to trade as public companies, an individual must qualify under SEC regulations as an accredited investor. That typically means that you need to meet at least one of the following conditions:
- Income of $200,000, or joint income with a spouse of $300,000, in each of the past two years.
- Net worth of more than $1 million, excluding the equity in your principal residence.
- Insider-type interest in the company in which you're investing, such as being an executive officer, director, or general partner.
If you meet those guidelines, then you can theoretically invest in venture capital funds. If you locate an upstart business or a venture capital company seeking funding, then you'll be able to provide that funding directly without either you or the company violating SEC guidelines.
Crowdfunding for average investors
In 2015, however, ordinary investors earned the right to invest directly in new companies without meeting the accredited investor standard. That's because of the crowdfunding regulations, which opened up the door to venture-capital-like investing to the masses. Under the rules passed in 2015 for the Jumpstart Our Business Startups Act of 2012, investors are allowed to invest up to $2,000 per year through equity crowdfunding. If 5% of the lesser of your annual income or net worth is greater than $2,000, then you can invest that larger amount.
In order to get access to crowdfunded companies, various portals offer listings of those seeking financing, such as Indiegogo and MicroVentures. Different portals offer different minimums for investment, but you can sometimes find opportunities that involve investing as little as $100.
Investing in venture capital managers
Venture capital can be a lucrative business, and the professionals have a clear advantage over most individual investors. With large staffs that know industries extremely well and have negotiating credibility, venture capital firms have power that gives them a competitive edge over the typical funding source.
Because of this, some investors prefer to invest in the companies that provide venture capital rather than investing directly in the start-ups that those venture capital sources fund. Also, because some venture capital and private equity managers trade publicly, you don't have to be an accredited investor or qualify for the crowdfunding regulation in order to invest in them. Among the names that are most popular in the space are Blackstone Group (NYSE:BX), Carlyle Group (NASDAQ:CG), and KKR (NYSE:KKR).
The downside to investing in venture capital managers is that you can't invest simply in one start-up. Even if the manager profits from working with a key new company, those gains will be diluted by the many other investments that the manager has made. However, some see that diversification as an advantage, allowing them to benefit from the general health of the venture capital space without having to decide which start-ups will be most likely to succeed.
Many see investing in venture capital as a way to make huge amounts of money quickly. Like any other investment, venture capital is as risky as it is potentially rewarding. By being smart about considering venture capital investments, you can find the best way that will fit with your investing philosophy and work it into your overall portfolio.