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Investment Decision-Making: General Principles & Differences in Venture Investing

While there are general principles and concepts applicable to all investments, this article identifies & describes 10 unique attributes & challenges related to investing in growth-oriented entrepreneurial ventures ('GOEVs'). Some researchers have claimed that venture capitalists are experts in addressing these issues. Based on evidence of their investment performance as well as research by myself and others regarding their management assessment capabilities, this assertion may be questionable. Nevertheless, VCs do have an appetite for this alternative class of investments and appear to possess some specialized knowledge to assist them in addressing concomitant challenges and making related investment decisions. My PhD dissertation provides recommendations for VCs to enhance their assessments and judgments in this area.

The principal goal of investing financial capital is to increase wealth. Wealth increases are generated through returns on invested capital (in the form of income and/or capital appreciation), together with a return of that capital, all of which are subject to risk and possibly uncertainty (for the distinction between risk & uncertainty, read the full article). The primary objectives of investing include safety (capital preservation), income generation, and growth (capital appreciation). Capital preservation is the most important: losing capital limits continued or additional investment and the prospects for achieving the other two objectives.

A key decision involves what to invest in - that is, specific asset selection. Asset selection involves choices from among alternatives because the total capital available is limited. Choices may involve rational decision processes but are also dependent on investor behaviour which involves return/risk preferences, diversification considerations, a method/means of evaluating identified opportunities, as well as emotional & psychological influences.

Venture capital investing leverages these fundamental concepts for an "alternative" asset class: development-stage private enterprises with perceived high-growth potential. These young business enterprises are characterized by unique attributes and challenges: the full article identifies and explains 10 including identification of the high-growth potential; transitioning through different stages-of-development; multiple uncertainties, high information asymmetry, and high risks; unbalanced management talent; the presence of various forms of conflict (internal & external); and, valuation challenges for pricing a deal due to a lack of economic performance measures to serve as a basis for reliably predicting future cash flows.

VCs are focused on overcoming these challenges to realize extraordinarily high returns for the benefit of themselves and their limited partners who provide their funds' investment capital. They use a combination of strategies to mitigate the inherent uncertainties & risks enumerated above. These include screening opportunities in accordance with their investment preferences, conducting extensive due diligence (including attempts at management assessments), and structuring deals to incorporate performance-based staged investments & management compensation, as well-as active involvement & communication through post-investment advisory services.

However, based on extensive reviews of extant literature and the specific research in my dissertation, several aspects of VCs' investment decision-making and post-investment processes could be enhanced for the benefit of all stakeholders through improved use of professionally-qualified financial managers.

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