Venture capital investment: what it is, risks and prospects

Venture capital investments are investments in innovative and promising projects that can grow quickly and bring significant profits. This type of investment is one of the riskiest, as only 25% of startups meet expectations. Approximately half of them perform worse than planned or go bankrupt. Only 10% achieve their goals, and only one out of a hundred becomes a “unicorn”, bringing investors multiple profits.

Most often venture capital funding is directed to the IT sphere, including the development of software, applications, ecosystems, cloud computing and AI that can attract the attention of a wide audience or large customers.

Let’s take a closer look at venture capital investments: their types, features, pros and cons, and opportunities for profitable investments.

What is venture capital investment

Venture investments are investments in fast-growing innovative startups with the aim of obtaining high profits in the future. They are characterized by a high degree of uncertainty and the risk of complete loss of investment if the original plan is not realized.

A venture capitalist is a professional (company or individual) with large capital and expertise in startups. The strategy is usually to invest in multiple projects, where successful investments offset losses from unsuccessful ones.

Characteristics of venture capital projects

A venture can be a startup with the potential for rapid growth and high profits. An example would be an innovative exchanger that uses new technologies to capture the market. A venture project must have:

  1. Innovativeness – utilization of new ideas and technologies.
  2. Technological – compliance with modern technological standards and a high profit-to-cost ratio.
  3. Leapfrog growth – rapid transition from a startup to a large business.
  4. Scalability – the ability to quickly capture markets and expand the customer base.

Types of venture investments

According to the stages of project development:

  1. Seed Capital – investments at early stages, when the project exists only on paper. This is the riskiest stage.
  2. Startup Capital – financing at the stage of testing and finalization of the product.
  3. Early Stage Capital – investments in startups that have started sales but have not yet achieved self-sustainability.
  4. Expansion Capital – funds for scaling up production and entering new markets.
  5. Bridge Financing – pre-IPO support.

By source of funding:

  1. Angel Investors – individuals providing early stage capital.
  2. Venture Funds – organizations that raise money to invest in startups.
  3. Corporate venture funds – divisions of large corporations that finance innovative projects.
  4. State venture capital financing – programs to support startups at the state level.

Principles of functioning of venture investments

Young ambitious projects often need capital. Banks do not lend without collateral, while venture capital funds and business angels can assess and take risks by investing in many startups. This allows them to hope that at least one project will succeed.

Startups grow quickly and need capital at all stages until they become attractive to large companies or IPOs. However, venture capitalists get a piece of the business and can influence its development, which also brings management skills and connections to startups.

Risks of venture capital projects

The main reasons why innovative projects fail are:

  1. Insufficient funding.
  2. Improper positioning in the market.
  3. Problems with the product.
  4. Inexperience or conflicts in the team.
  5. Inability to scale.
  6. Ineffective management of resources.
  7. Changes in industry or technology.
  8. Legal problems.
  9. Unsuccessful marketing strategy.
  10. Lack of customer focus.

Pros and cons of venture capital investment

Advantages:

  1. High returns.
  2. Opportunity for passive participation.
  3. A chance to become the owner of a large company.
  4. Tax benefits.

Disadvantages:

  1. High risks.
  2. Specific knowledge is required.
  3. Low diversification.
  4. High entry threshold.

How to become a venture capitalist

Venture capitalists are successful entrepreneurs who want to invest in new businesses. They can act individually, through crowdfunding platforms or as part of investment clubs. Investors must have sufficient capital, knowledge, choose a direction for investment, analyze projects and participate in their development.

Earnings on venture capital projects

For successful investing you need to:

  1. Have the necessary amount of money to lose.
  2. Be educated and follow the market.
  3. Choose the direction of investment.
  4. Analyze the business plan and the potential of the project.
  5. Negotiate the terms of the investment.
  6. Participate in the development of the company.
  7. Sell assets or shares in an IPO.

Conclusion

Venture capital investment is investing in high-growth startups with the aim of earning high returns. It is one of the riskiest types of investments, requiring significant capital and knowledge. You can enter the market as a private investor, through funds or crowdfunding platforms. The more developed the company, the lower the risks and potential returns. Investors earn returns when assets are sold in a takeover or IPO.

What is a spread in the financial markets?

Any trader or investor comes to the financial markets with the purpose of making money. He or she seeks to buy assets cheaper and sell them more expensive, capitalizing on the price difference between the associated commodities and expected market movements.

In any case, the trader analyzes the price and its fluctuations between sellers and buyers, which in financial markets is called a spread.

Let’s take a look at what a currency spread is and what other types of price ranges exist on exchanges.

What is a spread

In the financial context, the concept of “spread” (from the word “spread” – divergence) can differ depending on the type of asset. In general terms, a spread is the difference between two price values for the same or similar instruments.

For example, it can be the range between:

  • The prices of sellers and buyers in the market at a given moment.
  • Prices for one asset: currency, stocks, futures at the current moment and after a certain period of time.
  • Prices for the same type of commodity, but of different brands, etc.

The most common variant in trading and investing is the difference between the bid and ask price (Bid – Ask). This is a commission for each transaction, which makes up the broker’s profit.

This is how, for example, the currency spread is formed. The exchange glass helps to better understand this concept. It is a special table formed by a market maker, where all limit orders from sellers and buyers of an asset are reflected. Bids are placed depending on their proximity to the current quote: the closer supply and demand are to the current price, the smaller the currency spread is. Since orders on active pairs are quickly satisfied and removed from the stack, the spread is constantly changing.

The spread for CFDs on shares and other securities is formed in a similar way. It can be several dollars, cents or even a fraction of a cent, so it is usually denoted in points. For example, if the price of NASDAQ 100 index is 11760.5/11761.3, the spread will be 8 cents or 8 points. This value is displayed in the market overview and in the glass.

It is believed that the smaller the spread, i.e. the closer the price of buyers and sellers, the more liquid the asset. This means that a trader is highly likely to be able to buy or sell it at the right time at an adequate price.

Types of spreads

Depending on the type of exchange-traded or OTC asset, the concept of “spread” can vary.

Currency spread

If we talk about the spread as a difference between bid and ask prices, as in the case of currency pairs or CFDs, it can be divided into fixed and floating spreads.

A fixed spread does not change regardless of market conditions: even when important news is released, when supply and demand shifts sharply. This level is set and maintained by the broker. It is usually higher than the standard floating spread in a calm market and lower in times of increased volatility. Today fixed spreads are rare, they have been replaced by market spreads.

A floating or market spread depends on supply and demand in the exchange stack and changes according to the preferences of traders. Usually for volatile assets it is more favorable than the fixed one and can be equal to zero at times. However, at the moments of important news release such a spread logically widens, so many brokers warn their clients about it.

Market spreads

There are intermarket and intramarket price ranges.

Intermarket spread reflects the difference in the cost of the selected asset on different exchanges, which is typical for securities. An intra-market spread is the difference between highly correlated or related instruments, for example, between stocks and their ADRs.

A special type of intra-market spread is the calendar spread, which exists in the derivatives market. It shows the difference in the prices of contracts for the same asset with different expiry dates.

Futures spread

This type of spread represents a trading strategy. Unlike a currency spread, a futures spread is a method in which a trader simultaneously buys and sells contracts on identical or similar commodities to profit from the divergence of their prices.

A futures spread occurs when:

  • Buying and selling a contract for the same asset with delivery in different months.
  • Buying and selling futures on different assets with similar quotation dynamics (correlation).
  • Buying and selling contracts for the same commodity of different quality.

Factors affecting the spread size

The size of the currency spread and similar spreads is influenced by various factors relating to a particular financial instrument. The main ones are:

  • Liquidity of currencies and securities: The higher the liquidity, the lower the spread. A large number of traders and market participants interested in transactions with this instrument leads to an increase in buy and sell orders and increases the chances of quickly concluding a deal at the right price.
  • Volume of trades and transactions: On stock exchanges, large transactions lead to a widening of the spread as many limit orders are executed at the same price.
  • Transaction amount: If an asset is purchased for a very small or very large amount, there are additional brokerage fees that increase the commission.
  • News and Publications: The main drivers of markets. Buy or sell decisions are often made based on them. After news releases, demand or supply increases sharply, causing the spread to widen. Before important news, trading activity drops, liquidity decreases and the spread widens.

How to work with the spread

It is impossible to artificially influence the stock or currency spread, as it depends on market conditions. But in order to reduce costs, you can:

  • Do not trade at times of low liquidity and the release of important news.
  • Open accounts with floating spread and choose active trading hours.
  • Choose popular currency pairs and securities.

Spread is less important for long-term strategies, but in this case you should take into account another parameter – swap (if it is applied).

Opening positions with limit orders can significantly reduce risks and additional costs, especially for large transactions or work with unpopular assets.