Designing an investment portfolio isn’t for the faint of heart. There’s a lot to consider – balancing asset classes and creating a diverse mix of securities is just the beginning. Retail investors can do independent research, then use the tools and resources available from inexpensive online brokerage firms to build a profitable portfolio. However, that plan isn’t practical for investors with millions or billions to place.
While the top one percent typically has a portion of their fortunes in traditional assets like stocks, bonds, and real estate, most choose to expand into other types of investments.
Where do wealthy people put their money? In many cases, the answer is funding new ideas. They infuse cash into startups in hopes of profiting when entrepreneurs and innovators develop products and services capable of disrupting entire industries.
Such investments are known as venture capital – and the wealthy people who put their money into these opportunities are known as venture capitalists.
What is Venture Capital?
There are fewer than 4,500 companies listed on US stock exchanges. Those shares are publicly traded, and any investor can purchase them.
Of course, that doesn’t even scratch the surface when it comes to the total number of businesses in the US and around the world. Some of those will eventually make it to the public exchanges, but in the meantime, they have to find the money to operate.
When emerging companies are involved in advanced technology or new products, it takes a lot of money to get off the ground – far more than most entrepreneurs and innovators can supply on their own. That’s when they pitch their ideas to venture capital firms and individual venture capitalists.
The VCs attempt to identify the most likely to succeed, then they provide funding in exchange for a percentage of the profits when the company eventually triumphs.
Some examples of top venture capitalists include:
Bill Gurley (net worth $8 billion) of Benchmark – notable investments include Uber, GrubHub, OpenTable, and Zillow
Chris Sacca (net worth $1.2 billion) of Lowercase Capital – notable investments include Twilio and Twitter
Kirsten Green of Forerunner Ventures – notable investments include Dollar Shave Club and Jet.com
Each of these venture capitalists took on substantial risk when they invested in unproven businesses, and for every win, they had dozens of losses. For example, Benchmark was a major investor in WeWork, and the failure of cryptocurrency firm FTX generated losses for more than a dozen reputable venture capital firms, including Lux Capital, Third Point Ventures, and Tiger Global.
What Are The Types of Venture Capital?
When the wealthy are deciding where to put their money, their risk tolerance is key to determining whether and how they will participate in venture capital projects. Some startups are riskier than others based on all of the same factors that drive public companies: product, strategy, management, financial stability, and so forth.
- Seed Funding – This is the first step to taking a company from vision to reality. VCs provide the seed money to set everything up, including tasks like research and development, business plan creation, and market research.
- Start-Up Capital – This type of funding may include seed money, but in most cases, start-up capital is separate investment. A majority of venture capitalists are more willing to risk their cash once initial tasks like market research and business plan creation are complete. Start-up capital is used for the next set of activities, such as building prototypes, hiring staff, and purchasing large pieces of equipment.
- Series A – Also referred to as first stage or first round funding, Series A is the start of transforming a concept into a working business. These dollars typically go into the launch of commercial manufacturing, distribution, and marketing. More funding rounds may follow to turn the initial concept into a saleable product.
- Expansion Funding – Once a company has demonstrated its commercial viability, expansion funding allows it to grow. That might mean moving into new markets, designing additional products, or increasing manufacturing capacity.
- Late-Stage Funding – New companies that have demonstrated commercial success but aren’t profitable quite yet still need occasional cash infusions to keep going. Late-stage funding ensures the doors stay open until the company is self-sufficient.
- Mezzanine Financing– Mezzanine financing is also referred to as bridge funding. The bridge in question is the transition from privately-held company to publicly-traded company. Bridge funding is used to cover expenses while an IPO is in process.
The more established a company is, the lower the risk for venture capitalists – but as with any investment, lower risk means lower potential rewards. Wealthy people who put their money into seed funding see more impressive returns than their late-stage funding VC counterparts when they bet on winners.
Venture Capital vs Angel Investors: What’s the Difference?
Outside of the world of finance, the terms venture capital and angel investor are often used interchangeably, but they aren’t quite the same. Venture capitalists, whether they are individuals or VC firms, generally build entire careers around venture capital-related work. They evaluate potential investments, and once they have selected projects to fund, they are hands-on with managing and otherwise supporting the company’s success.
Wealthy people who haven’t made their fortunes in finance are more likely to qualify as angel investors. They provide the cash for one or more stages of funding, but then they leave the details to others. They don’t get involved in managing the company – they simply wait for the company to begin generating profits so they can collect their returns.
#1 Stock For The Next 7 Days
When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.
Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.
See The #1 Stock Now >>The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.