Difference Between a Hedge Fund & Venture Capital

by Tom Streissguth

Investing takes many forms, from simple to complex, safe to risky. If you have money you want to put to work, you should first prepare by researching the many different strategies available. For investors with a large amount of capital, hedge funds and venture capital are two popular options.

Hedge Fund

A hedge fund is a pool of investment capital that a manager invests on shareholders' behalf. In this basic operation, a hedge fund is similar to a mutual fund, but with a crucial difference: the complete discretion it gives the fund manager to invest where and how he chooses. This means hedge funds can hold any and all investment types, from the safest U.S. Treasury bond to the riskiest junk bonds, stock options and futures contracts.

Entrance Fee

Hedge funds have much higher minimum investments than ordinary mutual funds and place greater restrictions on withdrawals. Some hedge funds require you to stay invested a minimum of a year or more to avoid a run on the fund that could force it to liquidate its investments. Hedge funds tend to be riskier than mutual funds, and it can be difficult to ascertain how much their holdings are worth. Because hedge funds are not regulated by the SEC, potential investors must thoroughly research the performance and management before entrusting their money to a hedge-fund manager.

Venture Capital

A venture fund takes a more active role in its investments. It allows investors -- individuals as well as institutions -- to invest money in new companies and enterprises. The fund pools money from its partners and buys a share in companies that do not yet have the finances or history to successfully offer shares on the public stock exchanges. In exchange, the venture fund earns a share of the company's future earnings, if any, and its partners divide the proceeds according to their participation in the fund.

Venture Fund Risk and Return

Venture funds represent a high-risk, high-return investment for their partners. Many companies in which a venture fund invests do not yet have sales or profits, and some stand for only a concept or invention that has not yet been brought to market. Members of a venture fund may take an active role in the operation of the new company, taking seats on its board of directors or providing active advice and guidance. Once the company makes an initial public offering, the venture fund sells its stake and divides the proceeds to its own partners.

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