Venture Capital: How It Works and How to Invest in 2025
Venture capital allows investors to support the growth of startup companies in exchange for a stake in the business.
Many, or all, of the products featured on this page are from our advertising partners who compensate us when you take certain actions on our website or click to take an action on their website. However, this does not influence our evaluations. Our opinions are our own. Here is a list of our partners and here's how we make money.
The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments.
America is known for its entrepreneurial spirit and leadership in innovation, but transforming an idea into a viable business isn’t easy. Many startups rely on venture capital for funding and expertise, with the hope of generating handsome financial returns if and when the business takes off.
What is venture capital?
Venture capital is a type of private equity investment in startups and early stage companies. Venture capital investors provide cash, assets and advice in exchange for an ownership stake and future growth potential.
Venture capital is an important financing vehicle for startups. New, unproven businesses usually can’t access bank loans and other traditional funding sources, which often require profitability, a track record, collateral and credit scores. These are qualifications that fledgling enterprises usually don’t have yet.
How venture capital works
The venture capital process involves several parties.
Entrepreneurs: Founders or owners in need of capital and expertise to advance their business concepts.
Venture capitalists or VC firms: An individual or firm that provides resources (capital, know-how, networking) for startup companies and raises funding by offering investment opportunities to limited partners.
Limited partners: Private investors (usually institutions such as pension funds, foundations and endowments, family offices and high-net-worth investors) willing to invest in high-risk startups in an effort to capture potentially big returns and diversify their investment portfolios.
Investment bankers: Deal-makers who help r companies complete mergers, acquisitions or capital-raising events, such as initial public offerings.
Angel investors often fund early stage startups before venture capitalists get involved.
After the company begins to bring in revenue and requires additional investment, venture capitalists may enter the scene to help the company expand even further. As revenue grows and profit margins widen, venture capitalists typically exit and give way to other private equity investors.
VC firms connect the parties. They vet entrepreneurs and their companies to find promising investments. Then, they pool their deals into a venture capital fund, which VC firms market to limited partners to raise capital. VC firms supply funding and guidance to entrepreneurs to help their businesses succeed. They also work with investment bankers to assess potential exit options.
Stages of early funding
Seed: During this very early stage of development, entrepreneurs use seed capital for research and development to determine their product offering, target market and business strategy. Angel investors tend to be more involved here.
Early: As the business moves to scale production, operations and marketing, it may raise its first round of funding, called Series A. As the business grows and expands, successive rounds (Series B, C) may follow.
Late: When the business prepares to be acquired or to go public via an IPO, it may do additional funding rounds (Series D, E) so that VC investors can exit the startup and take their profits.
VC firms might compete to gain access to the best deals, but they also often support one another by investing together. Several VC firms might participate in a round of investment in a company, with one firm serving as the lead investor and the others as secondary investors. This helps to enhance the credibility of the startup and spreads work and risk across various firms.
Typically, the limited partners of VC firms are institutional investors such as foundations and endowments, insurance companies and pension funds or family offices. However, high-net-worth individuals who are accredited investors might also participate in venture capital funds and investments.
The minimum investment and qualifications required vary by venture capital fund offering. It's a good idea to talk with a financial advisor to see whether venture capital is a good idea for you.
Accredited investors are people who have earned income of at least $200,000 for the past two years ($300,000 with a spouse) or have a net worth, alone or with a spouse, of at least $1 million in investable assets (excluding their home).
Pros and cons of investing in venture capital
Potential for high returns.
Diversification.
Opportunity to innovate and share knowledge.
Illiquidity.
Transparency.
Cost.
Advantages of investing in venture capital
There are many reasons why investors are attracted to the venture capital industry.
Potential for high returns. As with many investments, the higher the risk, the higher the reward. This rings true when it comes to venture capital. Although many VC-backed companies fail, finding a "unicorn" — a startup that becomes worth $1 billion or more — can more than make up for the others.
Diversification. Investing in venture capital can help diversify a portfolio by including an asset class that has a different risk-return profile from traditional stocks and bonds.
Opportunity to innovate and share knowledge. Many investors also enjoy the excitement that comes with being involved in a startup. Often these companies are working to disrupt a particular industry and provide innovative products and services — and playing a part in that evolution can be appealing.
Disadvantages of investing in venture capital
There are risks to consider when investing in venture capital.
Illiquidity. You are generally locked into a long-term, illiquid investment. Since many startups take five to 10 years to mature, venture capital funds often operate on a 10-year time frame. That means profits may not be distributed back to investors until 10 years after the fund stops taking new capital commitments.
Transparency. Public companies have disclosure requirements; private companies generally don’t. In addition, startups often don’t have a lot of comparable companies against which to benchmark their value. These factors make it hard to know if what you’re investing in is worthwhile.
Cost. Minimum investments can be high. In addition, venture capital firms typically charge a management fee of about 2% of assets under management and performance fees (or "carry") of about 20%. This carry means the VC firm collects 20% of the profits the investment funds generate.
