Overview of the current situation in the venture capital market

Venture capital investments are investments in high-risk companies and projects at the earliest stages of development. This type of investment usually involves financing of innovative, breakthrough areas. Primarily, this is the development of previously non-existent products, the introduction of the latest innovative technologies and entry into unconquered markets.

Why do investors finance risky ventures? How can such business adventurism be justified? The fact is that, in case of recognition of a promising opportunity at the early stages of project development, investors in the future will be able to get an impressive increase in the put up capital.

Think about this. At one time, investments in a photo camera, a steam locomotive or an airplane would be super-risky. Of course, now these technologies are ubiquitous and familiar. But who exactly could predict and/or guarantee the tremendous success of these inventions in the first years of their existence?

The ability to recognize a unique idea in advance is a rare talent that basically relies on a huge amount of both one's own and someone else's professional experience (including negative one), knowledge of the laws of the market, the ability to quickly identify core RTBs and quite a bit on luck.

Today, the attention of professional investors is increasingly drawn to various technologies using blockchain, namely:

• cryptocurrencies

• bridges between different blockchains and solutions that speed up or reduce the cost of transactions

• lotteries, games (including gambling)

• NFT (but not only as art objects, but also as means of access, unique in-game items, insurance policies, etc.)

• proprietorship registers (real estate, precious stones, cars, etc.)

• medical records

  etc.

Due to its very essence, blockchain is able to integrate into, it seems, almost any industry existing on the planet. It is logical to assume that in the future its application will have a tremendous impact on the development of mankind. The quality of such influence directly depends on the projects that we develop today, on their humaneness, usefulness and transparency.

How do investors feel about blockchain technology? What is the difference between venture capital financing using cryptocurrencies and the classic one? How high are the risks for investors?

As you know, the first investments in blockchain projects began in the 10s of the current century: Ethereum was the first to crowdfund on the bitcoin blockchain in the second half of 2014. Thanks to the functionality implemented in Ethereum and allowing literally any person or project to create their own token, in 2017 the world saw the so-called ICO boom. This new form of attracting investment capital has not only allowed blockchain technology to develop into one that gives truly impressive opportunities, but has also made many national governments pay attention to this fast-growing and very high-risk sector. Largely due to this, rules and restrictions have appeared, and the practice of venture investment has been developed and continues to be supplemented by new approaches to attracting capital.

In the field of venture capital investments, the most active investors are located in the USA and the EU. Most often, venture investment in blockchain projects gets injected by specialized venture capital companies, investment banks and wealthy individuals (qualified investors and so-called business angels). Companies in need of funds often seek not only money, but also management advice, technological know-how, and especially connections. Realizing the novelty, instability and volatility of the market, almost all startups looking for investments want to enlist advice and expertise from renowned industry gurus.

Taking into account the complexity of technologies, the uniqueness of solutions and the non-standard situation in which potential investors find themselves, making decisions about participation in a particular project is often quite non-trivial.

According to The Global Startup Ecosystem Report 2021 (GSER2021), “... a very small percentage of entrepreneurs and investors who believe in their ideas are successful in building a business. According to the Startup Genome Report (report for 2021), 92% of launched startups die, 74% of Internet startups get closed due to premature scaling, overestimating their own strength and inflating the company's staff several times. Half of startups close within the first five years, and this is common across all sectors. This means that at the beginning of the journey, any entrepreneur and investor who has become his partner has maximum risks. It may seem crazy that there are people who are ready to support projects in the early stages, despite the fact that the probability of success at the moment will be several times lower than in a casino, and it will take several years to wait for a return on investment”.

According to statistics, about one company out of a hundred becomes a unicorn, but the profit from this investment fully covers losses in other projects. In the overwhelming majority of cases, investors make up a portfolio of investments in several startups at once.

Venture capital investments are most often provided at the design, launch or scaling stages of a project. The choice in favor of a particular project is most often made due to uniqueness of a new product, introduction of innovative technologies and ability to scale, as well as its social significance. Startups receive investment funds, most often by providing a share of ownership in the company or its shares in return (tokens in the blockchain environment). Thus, investors get decision making votes in a company and in the future they make a direct impact on its development. The return of funds to investors occurs at the time of the sale of their share in the company.

Many experts agree that the technological breakthrough that took place at the end of the last century was ensured precisely due to the breakdown of venture capitalists’ paradigm of thinking. The orders of magnitude that venture capital funds are ready to invest in high-risk projects have increased significantly (now the amount of investment often exceeds $100 million), and this made it possible for projects that could not have previously been financed under any circumstances.

One could assume that even more large investments would open the way for more disruptive companies. However, in practice, such reasoning translates into simply incredible financial losses. For example, online offline services such as Bird, Uber, Postmates, WeWork or Airbnb have been suffering heavy financial losses for many years. In fact, their business model is to sell $1 for a substantially lower price. For example, DoorDash turns $1 into $0.666, and Bird turns it into $0.37. This financial model is called “blitzscaling,” and it assumes a huge turnover, which will reduce operating costs. In fact, bringing colossal losses, such companies do not die only if they manage to inflate prices in time, having previously destroyed a number of adult companies on the market (banally all competitors).

What is the modern alternative?

It is quite difficult for high-risk projects to get a bank loan for development, and project financing may not suit the founders of a startup. Natural alternatives for them are venture funds, business angels and qualified private investors: high-level expertise, experience in real competitive conditions and a broad vision of the current market situation allow them to apply in practice the basic principles of venture financing:

1. Investment of funds takes place before the formation of the authorized capital.

2. A contract is concluded between the investor and the receiving party, according to which the venture investor enters the project as a co-founder. If the project is successful, the share of investors' profit does not necessarily directly depend on the size of the investment and cannot be more than 50%. Often, an investor helps a project thanks to his competencies: marketing, jurisprudence, technology.

3. If the project fails, its creators do not return the money to the investor and have no further obligations to him.

Let's note the most common expectations of investors:

• the presence of a motivated team of professionals. Most often, priority is given to teams that truly [and even passionately] believe in their project

• strong management

• medium-term development strategy

• clear prospects for monetization

• real positive business performance

• excellent marketing strategy

In other words, early stage venture capitalists invest more in a motivated and competent team that already has a clear plan of action. For such a team to successfully conduct business, it remains only to receive direct investments and competent advice from a professional on specialized issues. It is also worth noting that at present, many investment funds are competing for startups at the seed stage, where the risks are relatively low, which means that the rest of the investors with less capital are left with the most risky investments at the earliest stages.