Venture Capital. An Overview

Abstract or Introduction

Even though the reasoning to invest money into venture capital (VC) funds may vary according to the type of the investor, according to Bygrave et al. (1999), the main reasons include:

First, investors expect high returns on capital invested into VC funds. While a return of 30% p.a. was common, most investors nowadays are seeking for consistent 15-25% p.a., which is in line with comparing portfolio companies to quoted companies and adding a risk premium. Second, since VC target companies have a low correlation with quoted stocks, investors might aim for diversification effects for their overall portfolio. Third, as VC investments are highly illiquid, they provide a return premium. Moreover, the long-term horizon these investments especially fits investors, such as pension funds which have long-term liabilities. Fourth, beyond financial reasoning, investors might also consider VC due to relatively cheap access to the research and development of young companies, leading towards new ideas and products. However, since focus is shifting towards later-stage financing, this becomes less prevailing. Lastly, since young companies typically realise fast growth, they tend to create significant employment possibilities and thus represent a further investment objective of especially government-related bodies.

A further reason includes that many start-ups remain in the private market for many years, due to the large supply of private capital as well as the scrutiny of public markets. This phenomenon results in start-ups realising their high-growth phase while still being private. As a result, investors increasingly turn to the private VC market in order to benefit from these high-growth phases. Besides, investors in the VC market may aim to escape the high volatility inherent in public markets due to its very liquid nature.