Venture capital advantages and disadvantages: at a glance
- What do I need to know? Venture capital (VC) firms invest in start-ups and early-stage businesses through a specialised fund.
- What does it mean for me? Buying minority shares in multiple businesses spreads the risk of losing the money you invest and could provide substantial returns. But most start-ups fail, and VC is a long-term financial commitment.
- Why does it matter? Understanding the advantages and disadvantages of venture capital helps you balance your investments according to the level of risk you’re comfortable with.
The latest UK government data reveals that Venture Capital Trusts (VCTs) issued shares worth £873m to investors in the 2023-2024 tax year. Venture capital can be a lucrative investment.
But like all investments, there are no guarantees. And investing in VC comes with various limitations that could make it unsuitable for the unprepared.
In this guide, you’ll learn about venture capital advantages and disadvantages, and whether higher-risk investing is right for you.
What is venture capital?
Venture capital is a form of investment that allows investors to purchase shares at early-stage businesses with high growth potential. This is typically achieved through professionally managed venture capital funds.
The funds are run by specialist VC firms, which acquire minority stakes in startups and often act in an advisory capacity to these businesses. This is a different approach to private equity funds, which buy large shares in businesses to gain active control.
VC funding is typically provided in rounds, with further injections of cash released as the business hits growth milestones. The final stage of venture capital funding is known as an ‘exit’ event.
What is a venture capital exit?
A venture capital exit is the final stage of the process, where the fund returns their investors’ initial investment and any profits.
Exit events can include:
- listing the company on the public stock exchange
- selling the business to another company
- selling your shares privately to another investor
- the fund agreeing to a founder or firm buyback of your equity
Each of these options usually allow you to recover your investment as well as grow your wealth with additional returns.
How does venture capital work for investors?
Venture capital firms pool wealth from investors to buy stakes in multiple startup businesses. Funds often invest in different companies at once, helping to spread risk across a diversified portfolio.
When you invest in a VC fund, you own a share of the fund itself rather than the individual startups. So, your returns depend on the performance of the portfolio.
But investing in venture capital funds can invite risk, losing the money you put in.
According to the Office for National Statistics (ONS), just 38.4% of UK businesses survive for five years or more. And you’re often backing companies without an established track record of generating revenue.
Venture capital is typically a long-term commitment. You could lose access to your cash for around seven years or more, which allows enough time for startups to progress through funding rounds, scale their growth, and pursue an exit.
What are the advantages and disadvantages of venture capital?
Venture capital can be a valuable addition to a diversified financial portfolio, offering the potential for high returns.
But it also involves significant risk and long-term commitment. It’s important to weigh the advantages and disadvantages of venture capital before investing.
| Advantages | Disadvantages |
| Investing in multiple businesses to increase chance of success | High-risk, with few start-ups succeeding |
| Potential for high returns | Cash is typically tied up for seven years or more |
| Tax relief | Complex tax rules |
| Minority stakes with no ownership responsibilities | Management and performance fees for investing in VC funds and trusts |
| Access to innovative, high-growth private companies | Direct investments often require specialist knowledge and due diligence |
VC investments don’t automatically provide tax benefits unless the investment is structured under schemes like Venture Capital Trusts (VCTs), Enterprise Investment Schemes (EISs), or Seed Enterprise Investment Schemes (SEISs).
Different types of venture capital investments
There are different ways to invest in venture capital. Below you can learn about some of the common ways of structuring a VC investment:
- VC funds: Investing in a professionally managed fund that pools money to acquire minority stakes across multiple early-stage businesses. Your cash is typically locked in until an exit event.
- Venture Capital Trusts (VCTs): Listed trusts that invest in multiple small companies and offer tax advantages, such as Income Tax relief, tax-free dividends, and exemptions from Capital Gains Tax (CGT).
- Angel investing: Providing personal wealth to a startup at its earliest stage. Angel investors often take a more hands-on-role in the business.
- EISs and SEISs: UK government-backed initiatives offer tax relief on qualifying investments, made directly into startups or via specialist funds.
- Direct investment: Paying cash directly into an early-stage company instead of a pooled fund. Direct investment can offer greater control and potential, but your losses could be significant.
UK tax considerations for venture capital
Venture capital schemes aim to encourage investment through tax benefits, although each scheme is different and investments must meet certain criteria to qualify.
- Venture Capital Trusts (VCTs): 30% Income Tax relief on investments up to £200,000 per tax year (dropping to 20% in April 2026), tax-free dividends, and CGT exemption if shares are held for five years.
- Enterprise Investment Schemes (EISs): 30% Income Tax relief up to £1m (£2m for investment in knowledge-intensive businesses), taxable dividends, and CGT exemption if you hold your shares for three or more years.
- Seed Enterprise Investment Schemes (SEISs): 50% tax relief on investments up to £200,000 per tax year and CGT exemption if you hold your shares for at least three years.
Investing directly into a private company often means that standard tax rules apply, including the payment of tax on dividends and CGT.
Venture capital funds are typically structured as limited partnerships. This means investors usually pay Income Tax as well as CGT when they sell their shares.
The exact taxes and the amount you’ll pay depends on the investment, the amount you paid into the fund, and individual circumstances.
Taxes can vary significantly depending on the fund. If you’re unsure how investing in a venture capital scheme could impact your taxes, it’s important to speak to a financial advisor.
Frequently asked questions about the advantages and disadvantages of venture capital
What types of businesses are suited to venture capital?
Venture capital is best suited to companies with the ability to scale quickly and generate high returns for investors. Venture capitalists take significant risks by investing in unproven companies, seeking opportunities for rapid expansion.
Entering at an early stage allows VC funds to acquire larger equity stakes at a lower valuation and benefit from the company’s full growth journey if the business succeeds.
Venture capitalists also target businesses with high revenue potential, such as technology or science-based startups, or companies within innovative industries like healthcare, fintech, and biotechnology.
By comparison, small businesses that focus on steady, incremental growth, like retail or service industries, are generally less suited to VC.
These sectors tend to lack the rapid scalability required to justify the long-term commitment of tying up your cash.
Do many venture-backed companies fail?
Yes, a high percentage of venture-backed businesses fail.
Research indicates as many as 75% of venture-backed companies never return cash to investors.
What is the 80/20 rule in venture capital?
The 80/20 rule in venture capital refers to the idea that 80% of a fund’s total returns are generated by 20% of its portfolio.
This principle draws attention to the minority of high-performing startup investments that offset the losses of less successful investments.
What is the typical time horizon for venture capital?
The typical lifespan for a venture capital investment is seven to 10 years. But the exact timeline will depend on the fund and the companies it’s invested in.
The long timeline of venture capital investments includes multiple funding rounds and active growth management with the goal of achieving an exit to return money to investors.
How do venture capital firms make money?
Venture capital firms commonly operate under a “two and 20” fee structure.
This means firms charge annual management fees of roughly 2% of committed cash and take around 20% of the profits from successful investments before distributing the remainder to investors.
What are the alternatives to venture capital?
If you’re looking for ways to expand your investment portfolio and grow a large sum, there are several alternatives to venture capital:
- High-interest savings accounts: For more cautious investors, opening multiple high-interest savings accounts can grow lump sums while lowering risk. This is because you can usually protect your money with the FSCS (Financial Services Compensation Scheme). Opening a range of accounts can help you balance access to your cash with high interest rates.
- Private equity: Rather than investing in startups, you can invest in established companies, often buying significant or majority stakes to improve performance before exiting.
- Public markets: Buying shares in publicly listed companies gives you access to large-scale growth opportunities.
- Angel investing: Providing early-stage funding to startups allows you to purchase a stake and potentially gain a higher level of influence in the business.
Understanding the advantages and disadvantages of venture capital
As with any investment, it’s important to understand venture capital’s advantages and disadvantages before committing your money.
The potential for extraordinary returns can make VC an attractive investment. And it can add a unique element to your portfolio by letting you invest in the success of early-stage businesses.
But VC is a long-term and high-risk investment. You must be comfortable with relinquishing access to your money with no guarantees you’ll make a profit or even get it back.
This is where high-interest savings accounts can complement VC in your portfolio - balancing access with predictable returns.
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