What is venture capital? The complete guide to investing in early-stage UK businesses

Venture capital: at a glance

• What do I need to know? Venture capital refers to investing in small, innovative businesses to help them achieve rapid growth. But a significant number of new businesses fail, making it a high-risk investment.
• What does it mean for me? Venture capital investing can diversify your portfolio by supporting growth in the UK economy. But there are no guarantees you’ll make money.
• Why does it matter? Depending on your circumstances, you may be invited to invest in venture capital funds. Understanding how the system works is important before committing your money for the long term. 

According to data published by the House of Commons Library, 99.9% of all businesses in the UK were Small to Medium Enterprises (SMEs) in 2024.

Although businesses struggle to survive in their early stages, recent analysis from PwC has shown that the proportion of insolvencies coming from startups recently declined to the lowest level in a decade. 

So, what if you wanted to invest in small, innovative UK companies?

In this guide, you’ll learn about how venture capital works, why venture capital investing is often invite-only in the UK, and how you can earn high levels of interest between large investments.

What is venture capital and why would someone invest?

Venture capital refers to a type of business funding that targets small companies looking to scale up their operations. The businesses are usually highly innovative, operate in a competitive market, or attract investment based on the talent of the executive team.

When you invest in venture capital in the UK, you usually do so through a VC fund or a specially designated trust (known as a Venture Capital Trust or VCT).

Investing in venture capital is generally considered high risk. This is because the businesses themselves are young, may not currently turn a profit, or require significant Research and Development (R&D) funding to make their business commercially viable.

Even though PwC’s research identified that startups made up less than half of UK insolvencies in 2024 (46%), most businesses fail within three years of opening. So, why might you consider investing in venture capital?

Three reasons to choose venture capital investing

There are many reasons someone might invest, but three of the most common include:

• Growth: Most companies fail, but the ones that succeed can achieve sizable growth.
• Innovation: Investors could be inspired by the mission or creativity of a new company.
• Tax relief: Depending on how you choose to invest, you could qualify for a reduction in the taxes you pay. 

But there are disadvantages to investing in venture capital which are equally important to consider.

Three disadvantages of venture capital investing

Some investors choose not to fund venture capital due to:

• High risk: There’s no guarantee any company you invest in will become successful.
• Long commitment: It can take up to 10 years for you to receive a return on your investment.
• Tax complexity: If you qualify for relief, it can significantly complicate your tax status.

How venture capital works

Venture capital funding takes place in ‘rounds’, where companies acquire investment at different stages of their development.

Once you’ve invested in a company, you commit your money until an ‘exit’ event occurs.

What is an exit event?

An exit event is a moment that triggers a payment to investors. Some examples of exit events include:

• Mergers and acquisitions: A larger company purchases a smaller business.
• Initial Public Offering (IPO): Shares for the private company are listed on a public stock exchange.
• Buybacks: A company may purchase its shares back from investors. 

Unlike most publicly listed companies, with venture capital you’re investing in companies that sometimes have no track record of turning a profit.

As a result, the value of buying a stake in the business can vary dramatically, especially when a new funding round is completed.

What are the four rounds of funding for startups?

The four typical funding stages are:

• Seed: An initial investment to get an early-stage company up and running. It’s common for someone from a venture capital firm to take a seat on the board of a company to ensure the business follows the plan.
• Series A: Growth is the primary goal of Series A funding. Investments typically centre around increasing customer acquisition, such as developing a marketing team, and targeting product-market fit.
• Series B: By the time a company reaches Series B funding, it should be ready to scale operations. There’s usually a strong market case for the business, but investment is required to meet demand and expand aggressively. Series B is often where larger venture capital firms get involved.
• Series C: The company has a loyal customer base, with a proven track record of successful delivery. It’s common for more established businesses to invest in the company at this point, including banks or hedge funds. It’s possible for further funding rounds to exist beyond Series C.

But this depends on the type of company and the needs of the specific business you’ve invested in.

How VC funds operate

A venture capital fund is a limited partnership that exists to provide money to early-stage businesses with growth potential. There are two roles that are essential to the structure of a venture capital fund:

• General partner (GP): The ‘manager’ of the fund, legally accountable for operations.
• Limited partner (LP): Investors that provide the finances for the fund. 

Both General Partners and Limited Partners can either be individuals or organisations. But it’s common for venture capital firms to set themselves up as General Partners, taking on legal responsibilities as necessary.

Capital commitments vs. capital calls

LP investors agree to invest an amount upfront. But it’s often the case that you won’t pay this right away. This is known as a ‘capital commitment’ and it’s a legally binding agreement.

Whenever you’re asked to pay some of the amount you’ve agreed, this is known as a ‘capital call’.

Venture capital investments typically require you to commit capital for several years. As a result, some investors manage their remaining cash separately, building a portfolio of accounts using savings platforms – particularly where access and flexibility are important.

How VC firms make money

It’s common for a fund to charge a fee of 2% on committed capital. So, if you agreed to invest £100,000 in a round of funding, £2,000 of that sum would be reserved for the fund itself.

The GP often gets paid a percentage of the profits in return for managing the fund. This is known as ‘carried interest’ and is usually charged at 20%, but the exact amount depends on the fund.

It’s important to understand how the fees and management structure of the fund works before you agree to a capital commitment.

What kind of investor is suited to venture capital?

Not all investors are comfortable taking on the high risk of venture capital. But there are some characteristics that could indicate you’re relatively well suited to adding venture capital investing to your portfolio.

These include:

• Long-term focus: You’ve already got a healthy balance of short-term investments, and you’re actively looking for something with a long-term emphasis.
• Comfortable income: Your sources of income are generally stable, with enough money to cover both your expenses and achieve your savings goals.
• Ability to absorb losses: If your venture capital investments fail, you’ve not placed a strain on your finances. You view the success of an investment as a bonus rather than an essential outcome. 

But there are also reasons why you should think carefully before investing in venture capital.

Minimum commitments

Once you agree to commit, you’re legally bound to fund your investment when the company makes a capital call. And you’ll need to agree to a minimum amount to qualify in the first place.

Paperwork

As with any legal process, you’ll need to process a lot of paperwork. This can get overwhelming if you’re unprepared.

Lack of control

Investing at an early stage doesn’t guarantee control. This is because the fund is designed to help the company to grow, rather than acquire control over a business, which is more common in private equity investing.

How UK investors can access venture capital

In the UK, Financial Conduct Authority (FCA) regulations place restrictions on how organisations can market certain high-risk investments. For venture capital, this means it’s uncommon for funds or firms to put out wide-reaching calls for funding. It’s more widespread for venture capital firms to approach investors based on eligibility or prior relationship building.

There are a few exemptions to this rule for high net worth individuals (HNWIs) and self-certified sophisticated investors. But your access will likely still depend on the opportunities you’re offered, rather than the route you choose.

Once your eligibility has been established, there are a handful of ways in which you could be invited to fund venture capital. This can include an invite to join a traditional VC fund. But in the UK, there is also a unique legal entity designed to provide tax relief on your venture capital investments.

These are known as Venture Capital Trusts (VCTs).

The basics of Venture Capital Trusts

VCTs are a unique kind of trust created by UK legislation. Each trust is listed as a company on the London Stock Exchange (LSE) and invests in a portfolio of small companies to spread risk. The UK government encourages investors to buy shares in VCTs by offering the following:

 • 30% Income Tax relief, subject to a five-year holding period

 • tax-free dividends for investors

 • Capital Gains Tax (CGT) exemption on sale of shares

A VCT is different from investing in a traditional venture capital fund because you’re buying shares of the trust.

You may receive dividends when the VCT makes a profit from the companies it invests in. As with all investing, there are still no guarantees you’ll make money. You could lose what you invest.

Direct investing

It is also possible to invest into small companies directly, especially at a very early stage of development. This is sometimes referred to as ‘angel’ investing.

This form of funding usually requires a high level of involvement from the investor and significant due diligence. So, it’s important to consider how much time you want to dedicate and the financial risk you’re comfortable with.

In each case, venture capital of any kind involves taking a risk on businesses without a proven track record. This is the main reason why venture capital is different to private equity, though there are other features that make them distinct.

Venture capital vs. private equity

Generally, venture capital and private equity are two methods of investing in businesses in the hopes of making a substantial return. But while venture capital targets speculative value, built on the potential of untested businesses, private equity takes control of established companies, imposing strategic priorities at a board level to increase profitability.

This is a comparison of the key differences between the two:

Both private equity and venture capital investing involve significant risk, with no certainty you’ll make a profit. This means you could lose the money you invest.

It’s important to consider where you invest your money carefully, especially given the size of the commitment involved. Putting your money in low-risk, high-interest savings accounts can give you time to decide while your deposits grow.

Holding cash while you evaluate opportunities

According to recent research published by Flagstone, 38% of HNWIs hold more cash than they did three years ago. One of the primary reasons for this is to provide more time to find the right investment opportunities. Saving cash in high-interest accounts can also give wealthy investors the ability to balance access with more predictable returns in an uncertain economic environment.

This approach doesn’t prevent investors from taking appropriate risks to grow their wealth. Instead, it provides additional options, especially when cash forms part of a wider wealth plan.

Frequently asked questions about venture capital

Is venture capital high risk?

Yes. Venture capital investing is considered high risk because there are no guarantees the businesses you invest in will survive. Most businesses fail within the first three to five years.

How long do venture capital investments last?

In general, your investment could take between seven to 10 years to generate returns. But exact timelines depend on a handful of factors including the specific fund you join, the companies which receive the investment, and the number of investment rounds required.

Are Venture Capital Trusts the same as VC funds?

No. VCTs are unique to the UK and are specially designated trusts that are listed on the London Stock Exchange (LSE). A VC fund is a general term referring to a pooled set of investments.

What is venture capital in the UK?

Venture capital works slightly differently in the UK because FCA regulations govern who can invest and how funds can approach investors.

Firms and funds can’t market themselves to retail investors, and must be able to prove that the individuals they approach are high net worth individuals or self-certified sophisticated investors.

You can invest in VCTs in the UK by buying shares in a trust listed on the London Stock Exchange. VCTs may pay you dividends when the trust makes a profit. 

You can also get tax relief by investing in VCTs. But it’s important to check how this could impact your finances based on your personal circumstances.

How does a VC make money?

A venture capitalist is someone that funds a company at an early stage in exchange for a share of the business. If the company is successful, you could earn a substantial sum in exchange for your initial investment. But most companies fail, and there are no guarantees of a return.

By contrast, venture capital funds are entities where multiple investors pool their resources, usually investing in multiple promising companies at once to reduce risk. Funds make money by charging fees, often a percentage of the amount that investors agree to spend (known as a ‘capital commitment’).

Investing in venture capital to support innovation

For HNWIs looking to support innovative new businesses in the UK, investing in venture capital can add an exciting new element to a diverse portfolio. But VC funding is high risk, so it’s essential to consider whether you’re willing to lose the money you invest.

Careful financial planning can help you determine whether you want to move forwards with opportunities when they arise. For some investors, VCTs can offer a way to participate in venture capital with tax advantages that help offset some of the investment risk.

Before you invest, speaking to a financial adviser can help you understand the impact of investing based on your personal circumstances. 

While you decide how to invest your cash, placing deposits in high-interest savings accounts can help your money grow over time. This lets you focus on finding the right opportunity, without compromising on generating returns.

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