Many people are willing to accept the risk of losing a dollar on a lottery ticket, while others find it acceptable to lose several million dollars! As a result, risk and vulnerability can be viewed as relative concepts. Cryptocurrencies are growing rapidly, and many people compare them to gold. As the crypto industry matures, we are seeing more and more traditional and retail investors entering the market. It has become increasingly common for institutional investors and venture capital funds to consider investing in digital currency businesses. It is widely acknowledged that crypto startups are highly valuable and can be viewed as viable investment opportunities.
This article from Mazdax Academy provides an overview of venture capital in the cryptocurrency sector.
What is venture capital?
A great company begins with a great idea, but even the most brilliant ideas cannot succeed without financial support. The successful development of a startup requires adequate funding, and venture capital is an essential component for many entrepreneurs in the early stages of the business.
Venture capital is a form of private equity that provides funding to early-stage startups and emerging companies that have very little operational history and great growth potential. In exchange for financing, technical support, and management expertise, start-up companies sell ownership stakes to venture capital funds.
In most cases, venture capitalists assist the managers of start-up companies in tracing the progress of their development and growth. It is common for startup founders to have a deep understanding of their chosen business industry. However, they may lack the skills and knowledge necessary to nurture and grow the company. Venture capitalists, on the other hand, specialize in the development of new companies.
Venture capital is a form of alternative investment that is typically available to accredited investors and institutional investors. VC funds are typically invested in by pension funds, large financial institutions, high net-worth individuals (HNWIs), and asset managers.
An understanding of venture capital funds
Venture capital funds consist of a group of investors seeking to make a significant amount of money quickly. Prospective investors are invited to participate in these funds by the fund managers.
Managers of venture capital funds devote considerable time to evaluating the potential growth of thousands of projects. Although venture capital firms are cautious investors, they are interested in expanding their business.
The majority of startups choose venture financing when they are not yet ready to go public. Additionally, they may not be able to raise funds from retail investors.
On the other hand, venture capital funds do not restrict their interest to well-known crypto firms. Many venture capital firms are now taking advantage of emerging business models related to cryptocurrencies, which provide derivative services to individual consumers. Companies offering cryptocurrency tax reporting software, cryptocurrency charting software, and similar services are examples of this type of business.
There are, therefore, several significant differences between venture capital and private equity deals. In venture capital, the focus is typically on early-stage companies, while in private equity, the focus is on larger, more established companies in need of an injection of equity or for an opportunity to sell some of the shares of their founders. The company’s founders are expected to transfer part of their shares in exchange for equity in the company.
Who are venture capitalists?
It is important to keep in mind that venture capital investments do not depend on hasty and careless decisions. These investors obtain sufficient information before making their decisions and act with full knowledge of the risks involved. To put it simply, risk tolerance refers to the investor’s capacity to bear the risk and their ability to manage it.
Investments by venture capitalists are generally made with a long-term perspective. Investors’ risk tolerance increases significantly when they have a long-term investment horizon. In the absence of a short-term intention to use your capital, you can rest assured that the market will reach its final equilibrium after the transient fluctuations have passed.
The primary objective of venture capitalists is to maximize their returns. The desire to earn returns is so important to this group of investors that they are willing to take on a great deal of risk in order to do so.
Venture capital structure
Venture capital financing typically consists of five stages. In some cases, additional stages may be added if the funding goals of a previous round have not been met, or if the founders wish to seek additional funding. Let’s take a closer look at these five steps below.
Step 0: Sowing seeds
In the seeding stage, team members determine whether the founder’s idea can be transformed into a product. Seeding is often overlooked as a formal stage since it involves ideation. It is typically limited to a small circle of family and friends at this stage, and stocks are not included.
The founder may be able to attract angel investors at this stage if he knows the right individuals. As opposed to venture capitalists, angel investors are very wealthy individuals who, if they are confident in the founder’s abilities, can ignore the validity of the project and enter it.
Step 1: Initial financing
This is a short-term financing round. The purpose of this stage is to test the market viability of the product. Tools such as market potential analysis are used by startups to determine their market viability. Market potential analysis, as its name implies, provides a framework for conducting market research and determining whether a product has market potential.
The startup may also be required to provide financial documents such as profit and loss statements, Pitch Decks, cash flow projections, project roadmaps, etc. to convince the venture fund that their product is worth investing in.
Series A: Seed Funding
In Series A, things start to get serious and the company goes public. Startups don’t need to apply as this round is reserved for early-stage cryptocurrency companies. They have a strong product, a loyal community, and a steady cash flow.
It is important to know that these companies are looking for capital that will assist them in expanding their products. As the product or service of the company has already been approved, investors face much less risk at this stage. Additionally, the company focuses on customer acquisition and marketing.
Series B: Seed funding
During Series B, the company will focus on further product development, sales, and marketing. Scalability is a major concern for Series B rounds. Companies that have reached this stage are in the development stage. The company is seeking opportunities to expand its operations and gain access to new markets. Companies at this stage have broad customer bases, it goes without saying.
In order to accelerate their expansion, the companies plan to invest the funds in building a capable team and strengthening their product. An appropriate investment should be made in the marketing and sales department, human resources, business development, and customer service departments.
Series C: Development Phase
The development stage is the last formal round of venture capital financing. During this phase, a business plans to expand into other markets and develop its product lines. Series C funding is typically awarded to companies that are already established in their field. The Series C of financing provides them with the opportunity to develop new products or services and introduce their activities to international markets.
In this stage of the company’s development, scalability can also be achieved through the acquisition of other businesses. Suppose a cryptocurrency brokerage company finds success in the United States and wishes to expand into the Canadian market. Additionally, the company may attempt to introduce financial services that are outside of its current scope.
It should be noted that the investment risk at this stage is lower, but the potential return is also lower. It is expected that a startup at this stage of development will be able to generate enough revenue with a commercially available product. A majority of the companies receiving funding in the development phase are two to three years old.
Additional series (optional): Pre-IPO stage
There are several reasons why companies plan to list their shares on the stock market during the Pre-IPO stage. As a result of going public, companies gain access to investors of all types and additional capital, as well as an increase in public confidence and a significant amount of publicity.
As part of this round of financing, the company is planning to carry out mergers and acquisitions, eliminate competitors, and prepare for an initial public offering.
Venture capital companies and the crypto industry
There is a great deal of room for growth in the cryptocurrency industry, as it is still in its infancy. Cryptocurrencies have a bright future and many venture capital firms do not want to miss out on what might be the greatest investment opportunity of our time. Despite the volatility of the crypto market, VC firms that are confident in blockchain and cryptocurrency companies are willing to take on greater risks.
There is no difference between venture financing in the crypto market and regular venture financing. Although hedge funds are considered mainstream because of their use of traditional financing methods, they are increasingly looking into cryptocurrency. A significant contributing factor to this increase is the decision by major advertising platforms such as Facebook (Meta) and Google to lift the ban on cryptocurrency advertisements. As crypto becomes more accepted by mainstream investors and institutional investors, venture capitalists are increasingly considering crypto as a low-risk investment opportunity.
It should be noted, however, that this can be viewed as a double-edged sword. The multitude of investments has led to thousands of new projects monitoring this market. In other words, even though there are a handful of scams out there, the majority are risky investments.
Despite this, many venture capitalists remain interested in investing in crypto startups, which can offer the highest returns in any industry. We must also emphasize that VC fund managers require skills associated with risk calculation and risk management.
Advantages and disadvantages of Venture capital in crypto
The main advantage of receiving venture capital is that it provides legitimacy to crypto startups. As a result of this legitimacy, more capital can be attracted from retail investors. As a result, ICOs and other cryptocurrency fundraising methods present lower barriers to entry. In many cases, all that is required to launch an ICO is a website and a thorough white paper.
A venture fund, on the other hand, will perform a much more thorough due diligence process. This includes examining the health of the project and the ability of the team to fulfill future promises. In addition, they conduct community and market research in order to predict profitability. The investment of VC capital leads to the consolidation of relationships and connections between different industries. Therefore, if there are any challenges in a field with which you are unfamiliar, the connections of a venture capital firm may prove useful.
It is well known to venture capitalists that not all projects are successful. While it is true that their primary goal is to make money, if a company cancels, there is no obligation to reimburse the funds. Furthermore, VC investment funds have been accepting investment risks for a long time and are familiar with the rules of the game. They may also be able to provide valuable investment advice to a number of crypto companies based on their experience.
There are some advantages and disadvantages associated with venture capital financing, including:
+ Providing start-up capital to companies in the early stages of their development.
+ In contrast to bank loans, venture capital does not require companies to have liquidity or assets to raise capital.
+ A venture capital firm can provide consulting services to a new company.
– It is common for venture capitalists to demand a large share of the company’s equity.
– Due to investor demands for immediate returns, VC-backed firms could lose creative control.
– VCs may also pressure the company to exit rather than pursue growth over the long term.
Types of venture investment contracts in Iran
In general, there are three models or methods for implementing a venture investment contract in Iran:
1- Stock contract
Currently, the stock contract is the most common method of implementing a venture investment contract in Iran. This method consists of an exchange between the investor and the startup founder.
Based on this model, startup managers give a percentage of the company’s shares to the investor in exchange for receiving financial resources.
2- A loan that can be converted into shares
In the second method of this contract, the investor offers a loan to the owners of the company that will be converted into shares as the business grows. According to this method, the founders are not required to return the investors’ principal and profits after making a profit; instead, they transfer a percentage of the company’s shares to them.
3- Royalties model
Using this method, the investor receives shares equal to the amount he has invested. Alternatively, he can harvest and sell a portion of the product. Obviously, if he takes advantage of this option, he will have to return his shares to the startup in proportion to the amount of harvested product.
Venture capital index
Here we provide an overview of the most important performance indicators for venture capital funds.
1. Participation in the management of companies: A venture capitalist’s role is not restricted to providing financial resources, nor do venture capitalists have a passive attitude towards the performance of their investable companies. Since these investors participate in the ownership of start-up companies, they consider themselves responsible for their success and seek to maximize their returns on investment.
2. Managerial evaluation: A majority of venture capital funds are invested in young and emerging companies that are experiencing rapid growth and are poised to become significant economic players in the future. However, recognizing this inherent power is not an easy task. This is because these companies may be in a stage where they do not have a practical product or an organized enterprise.
Therefore, such investments are subject to a great deal of risk. As a result, it is important to conduct a very accurate evaluation of such companies at an early stage.
3. Risk tolerance: An important indicator of venture capital is the risk tolerance of companies. It is because of this key characteristic that many start-ups and emerging companies seek venture capitalists for funding.
4. Profitability motivation: As stated in the definition of venture capital, it involves the acceptance of high risks in order to achieve a high return on investment. Obviously, investors must accept risk to earn more profit. Otherwise, if they are seeking small and insignificant returns, they can settle for bank interest rates or other safe investments (such as bonds and partnerships).
5. Long-term vision: In general, technology development has no place in short-term planning. In other words, if the short-term view dominates these funds, they will gradually move away from the concept of venture capital. Further, their performance will no longer correspond with the goals of technological development and will become similar to that of financial institutions and banks.
6. Professional management: The role of venture capital is also to facilitate the flow of capital. To put it another way, a successful venture capitalist identifies not only quality investments, but also new investors who are interested in the project and will ensure its continuity and future growth; all this requires professional management.
Conclusion
We have discussed the history, operation, benefits, and drawbacks of venture capital in this article. In accordance with its name, this investment involves a high level of risk, but on the other hand, there may be a large amount of return; this makes it a very popular way to finance emerging companies and startups.
Please feel free to leave a comment if you have any questions or tips about venture capital.
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