Everyone knows how Amazon started as a simple book store or how Meta began in a dorm room. At some point all of today’s great companies were just a passion project, a great idea in need of capital, employees, and the first real customer. While some ideas grow to become companies organically without outside investors, most companies need help. They need capital, they need expertise, they need connections and support.

Venture capital investing is the process by which these great ideas get funded and become dynamic companies capable of scaling and growing profitable. The return profiles for successful companies can be huge, but it’s an incredibly nuanced and risky part of the investing world and not suitable for everyone. Nonetheless, it’s where the best ideas are tried, tested, and eventually brought to fruition.

Investing in Venture Markets

You can’t invest in the venture space without recognizing that failure is an essential part of the creative process. Venture companies are dreaming big – and not every moonshot works out. In fact, most small companies end up failing and shutting the doors. Investing in the space successfully hinges on one or two ventures succeeding within a much broader portfolio. The companies that make it often hit escape velocity – they can hyperscale and the the returns can be exponential. The returns on a single venture investment could be enough to justify dozens of failures.

The complexity of the market is further complicated by the lack of transparency and minimal reporting requirements. The environment is rife with fraud and exaggeration. A great idea may be nothing more than an idea and may have no substance or practical marketability. Successfully navigating the venture space consequently requires a nuanced understanding of how businesses are run and an astute approach to avoid falling prey to exploitation. Subject matter expertise is also essential to see through the sales pitch and understand the substance of the idea.

Finally, we have to take a moment to discuss how hyperscale growth can be risky even when it succeeds. Unlike mature companies who are kicking off cash to investors, most venture investments are purely growth oriented. That growth can be awesome, but can also lead to long investing time frames – venture investing is not for those who need liquidity, even if they can handle the risk.

However, for those with the risk appetite, the time, and the expertise, the venture space can be incredibly rewarding. Diversified and done properly, a venture capital fund can be a vehicle for cutting edge ideas to become wonderful portfolio investments experiencing exponential growth over time.

Timing The Economic Cycle

This already exciting space is even more intriguing because of where we are in the market cycle. Smaller companies are typically the most exposed to the broader economic cycles and the venture space is no exception. The past two years are a great example. Inflation and interest rate hikes put a damper on the economy and small companies took it on the chin. Exuberance in 2021 turned into austerity in 2022; it’s hard to overstate the monumental shift in perspective. Think about some public market companies with established user bases and real products – companies like Teladoc or Zoom or PayPal. In 2021 their valuations were extended, and in 2022 and 2023 those valuations came tumbling downwards.

The same thing happened in private markets and in venture capital markets. In many cases it was actually worse in venture markets as the underlying products were far less tried and tested. The stress on the venture space was further exacerbated as soaring interest rates and a crisis of confidence caused the collapse of the venture-oriented bank SVB. Consequently, raising funds in venture markets today has become much more difficult. Many ventures have shut their doors and those still standing are fighting to raise capital at any valuation. Rather than looking for growth and appreciation, founders are looking at flat fundraising rounds as a victory.

This is also reflected in the IPO market. Many successful venture companies have delayed their public market debuts and have opted to stay private until capital markets start to open back up. The lack of activity in the last year or two stands in stark contrast to the successful listings of companies like Snowflake or Doordash when markets were less troubled.

However, companies resilient enough to weather downturns tend to flourish when market conditions improve. Difficult market conditions make it essential to not only have a good idea, but to become a good operator. Conserving cash, focusing on profitability, finding ways to efficiently acquire customers – these are lessons that companies learn during downturns. Taking that expertise to the broader market when capital markets start to unlock can lead to rapid growth both in terms of profitability, and in terms of the valuation of the firm.

Read the full article in Forbes.

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