The booming business of venture capital has become more than just a new way to fund startups.
Venture capital is now a full-fledged business that requires investment, risk assessment and management, as well as operational support.
Two common issues confront venture capitalists when raising funds for their portfolio companies.
These operational challenges are commonly referred to as the “VC trap” or the “VC company” problem. Let’s take a deeper look at each one so you can avoid falling into either one of them.
Venture Capital Investment Company
The growing popularity of the venture capital business has led to more and more firms entering the market with the promise of funding the next Facebook or Google.
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However, this has also led to an increase in firms that are trying to raise funding for the sake of raising it.
This is a serious problem that can be referred to as the “VC trap.” Venture capitalists like to invest in companies that are solving a real problem and that have the potential to become a great business.
It doesn’t matter how good the idea is if it doesn’t have the potential to become a successful company.
Weak Investment Strategy
Venture capitalists are often eager to invest their own money into high-risk, high-reward ventures.
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Many fund managers don’t understand the need for a balanced approach to risk and reward.
While it’s fine to be overly cautious, a venture capitalist who takes very few risks with their own money may not be the best choice for your company.
From a risk-reward perspective, a business with a high potential reward and low potential risk is likely to end up a failure.
However, a company with a low potential reward and a high potential risk is likely to succeed.
A venture capitalist who only invests in ventures with a high potential reward will have a tough time finding investments that make good returns.
In contrast, a venture capitalist who also invests in ventures with a high potential reward will potentially end up with a lot of failures on their investment portfolio.
Low Liquidity and High Turnover in Fund
Venture capitalists have to make many investments, and it’s difficult to always have enough funding available to invest in a large number of companies.
In addition, investors typically have the option to sell a portion of their fund and get cash returns at any time. This means that fund managers often have to sell their investments shortly after making them.
This can lead to significant liquidity issues, since a high amount of fund managers’ money ends up being sold at a price that doesn’t necessarily reflect the fund manager’s perception of the company’s valuation.
A low amount of liquidity in a fund means that fund manager has to commit more of their money to make an investment.
This can be a good thing for a fund manager who wants to make a large investment in a company.
However, a fund manager who only wants a little bit of money committed to an investment will have to wait longer to get their money back.
Too Risky Investment Portfolio
Typically, venture capitalists make investments that are in the range of 10–15% of the total fund. As a result, these funds have to invest in a large number of companies and have to take a high amount of risk.
If a venture capitalist has too many investments with a high level of risk, they will end up with a portfolio that’s too risky to make good returns.
Fund managers who have to make only a few investments with a high level of risk will have to wait a long time to end up with a high enough return to earn their management fees.
On the other hand, a fund manager who has a low level of risk in their portfolio will have a difficult time finding investments that make good returns. This can quickly lead to fund manager closures.
The business of venture capital has changed dramatically since the early days when investors viewed it as an experimental way to find the next big innovations.
Now, it has evolved into a full-fledged business that requires investment, risk assessment and management, as well as operational support.
Many venture capitalists have limited experience investing in companies outside of their own fund. They don’t understand the need for a balanced approach to risk and reward.
They also tend to invest too much in ventures with a high potential reward and not enough risk. In addition, many venture capitalists don’t have enough liquidity in their funds.
This means they have to commit a large amount of their own money. They also tend to invest in a high number of companies with a high level of risk.