What is venture capital?

For investors looking to diversify their portfolios with alternative assets, venture capital is a  popular option. This asset class is known for producing both exciting new technology for consumers and high returns for investors. But it’s a high-stakes investment strategy – one that comes with substantial risks.

In this blog post, we explore the fundamentals of venture capital, from understanding what it is and how it works to examining potential risk factors, and we show how it compares to franchise investing.

What is venture capital?

Venture capital (VC) is a subset of private equity that provides financing for startups and small, emerging companies. Venture capitalists are typically wealthy individuals who pool their money in order to invest in businesses they believe have significant potential for growth. In return for ownership stakes in their company, entrepreneurs receive capital as well as additional support, which may include valuable business connections and managerial guidance.

Differences between venture capital and private equity

While venture capital shares a number of similarities with the broader spectrum of private equity (PE) investing, it differs in some significant ways. 

One of the most distinctive features of VC is the company stage and risk level associated with investments. Venture capitalists tend to focus on young companies, sometimes going as far as specializing in a particular industry or region. Statistically, many of these businesses are likely to fail, so VCs will build a portfolio of multiple companies to mitigate this risk. A single large exit can quickly make up for any losses. 

In contrast, PE firms build portfolios of mature companies. They make relatively few investments, but these tend to be much larger in scale.

Another key difference lies in the operational approach taken by these investors. PE firms will almost always secure the majority stake in a portfolio company with the intent to expand or revamp and eventually sell the business. This may involve completely restructuring operations, which is why many employees start dusting off their resumes when a PE firm comes calling.

VCs typically take a much more involved approach to their investments. They very rarely acquire a controlling stake, instead aiming to share equity with other investors and work with founders on a personal level to ensure the company’s success. 

Why invest in venture capital?

For investors with an interest in alternative assets, venture capital can be a dynamic and exciting addition to an existing portfolio.

Benefits of VC investing

This asset class has a number of features that make it attractive to sophisticated investors:

• High potential returns: Venture capital has consistently outperformed public markets for decades and has the potential to pay outsized returns. Many of the industry titans we know today, like Google, Uber, and Amazon, were venture-backed and their success has made some of their early investors a fortune.
  
• Diversification: VC investment happens exclusively in the private sector, which may help diversify a portfolio away from public markets. Limiting exposure to a single type of asset helps mitigate risk and shield investors’ returns from adverse market forces.
  
• Access to emerging technologies: Innovation is at the heart of what makes VC investing so exciting. Investors get a front-row seat at the cutting edge of technology as their capital is used to back determined entrepreneurs with new and potentially world-changing ideas.

Challenges of VC investing

As with any investment vehicle, VC can have its fair share of speed bumps.

• High risk: As mentioned previously, early-stage businesses run a high risk of failure. Though savvy VCs do extensive due diligence before investing in a company, there’s always a chance that it could be sunk by geopolitical changes, human error, or some other unforeseen circumstance(s).
  
• Competition: Unfortunately, there’s only so much equity to go around. VCs with smaller funds or networks may not see the same deal flow as their larger counterparts and miss out on valuable opportunities.
  
• Limited liquidity: VCs only realize a return on their investments when a portfolio company is acquired or makes an initial public offering (IPO). Growing a business from a nascent startup to an exit-ready operation can take years or even decades, making potential investment horizons extraordinarily long.

Trends in VC investing

With shows like Shark Tank putting venture capital in the public spotlight, interest in this asset class is only increasing.

The rise of retail investors

VC investing was once almost exclusively dominated by pension funds, big institutional investors, high-net-worth individuals, and deep-pocketed wealth managers. However, changes in federal investment regulations and the adoption of new technology have made it easier for retail investors to access the space. Most recently, the U.S. Securities and Exchange Commission (SEC) expanded the definition of “accredited investor,” which made VC deals fair game for a broader segment of the retail investor sector.

Sluggish post-COVID markets

Unfortunately, venture capital is not immune to the market forces that have also been causing issues for the economy at large. VC investment activity has slowed significantly in the wake of the COVID-19 pandemic due to anxiety around inflation, turmoil in the banking sector, and rising political tensions in Europe and Asia.

How VC investing compares to franchise investing

As alternative assets, both VC and franchise investing can be a productive means of diversifying a portfolio away from the public markets. In addition, both investment vehicles offer the opportunity to generate passive income. In VC, this would come in the form of dividends generated by a portfolio company’s successful exit.

However, franchise investing provides a handful of advantages over venture capital:

Proven business model: The biggest difference between VC and franchise investing is the track record of the businesses receiving the capital. By definition, a franchise is an established company with a proven business model, making it a good choice for investors who want to manage risk. In contrast, VC focuses almost exclusively on early-stage businesses with little to no track record, which creates a much higher level of risk.

Recession-resistance and inflation hedge: Franchise investors look for businesses with a successful track record in order to minimize volatility. The aim is to leverage this stability during downturns, since the most successful franchise networks offer goods and services in recession-resistant industries. In addition, the price of these goods and services rises with inflation, which can help protect dividends. These adverse market conditions can cripple startups and other early-stage companies, to the detriment of any VC investors.

Lower initial capital outlay: Traditional VC investing requires a large outlay of capital upfront, typically in the millions or even billions of dollars. This is why the asset class has been accessible only to investors with deep pockets. Franchise investing, on the other hand, can require as little as $10,000 to launch a turnkey business.

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FranShares brings the ease of private equity investing to franchising

Until recently, franchising was a hands-on investment model. Investors had a choice between owning and operating directly, or hiring a management firm to handle the daily operations of their business. 

FranShares brings the passive power of private investing to the franchise model with a portfolio approach that lets individual investors add this important asset class to their asset mix without direct operation or location ownership.

Benefits of investing with FranShares

We combine deep industry expertise with a zero-fee approach to ensure our investors maximize their long-term returns – without the risk of losing their shirts. Our mission is to help investors reap the benefits of franchise investing with a unique business model that offers:

• Passive income
  Our best-in-class franchise management team ensures that our investors enjoy truly passive income through quarterly distributions – without managing the franchise. In other words, we do the legwork while you sit back and enjoy the returns.
• Equity appreciation
  The value of your franchise investment may increase over time and may provide secure, long-term passive income.

• Flexible capital commitment
  We offer accredited and non-accredited investors the opportunity to invest for as little as $500, although our model also appeals to ultra-high-net-worth investors. Our platform allows everyday people to become fractional franchise owners with the ability to invest the right amount of capital for their own personal circumstances.
• Diversification
  Diversify away from the stock market and other publicly traded assets while owning a portfolio of franchises across different geographies and industries, which creates an effective buffer against challenges that may shut down a single franchise or location, such as service franchises closing temporarily during pandemic lockdowns.
• Low volatility
  Unlike other assets, which may experience considerable fluctuations due to investor sentiment, the growth in value and disbursements from franchise investments are determined over the longer term by the business operations of the franchises.
  

Ready to add franchise investing to your portfolio?

If you’re an investor who is looking to incorporate alternative assets into your 2023 strategy, investing fractionally with a FranShares franchise portfolio offers high earning potential and diversification in a completely passive model. 

To learn more about FranShares and this unique opportunity, sign up to our platform on our home page.