— Q: Can you explain the difference between hedge funds and venture capital?
A: You’ve probably heard of many types of alternative investments, such as hedge funds, private-equity funds and venture capital funds. While all three are pools of money used to invest, they have very different objectives and target different opportunities.
At their most fundamental level, hedge funds, private-equity funds and venture capital funds are like mutual funds. They all gather cash from investors, pool it and invest the money in businesses expected to become more valuable over time. The differences have to do mainly with the types of investors and the types of companies the funds invest in. Here is a quick explanation:
•Hedge funds. These are pools of money that largely fly under the radar of regulators. Since they only accept money from investors with plenty of cash to lose, they’re allowed to invest in just about anything. Typically, hedge fund managers are traders more than investors. They’re looking to take a big position in an asset, be it a stock, commodity or foreign currency, hold it for a short time and sell it. Hedge funds also are free to sell short — that is, bet against assets and profit if the value of the asset falls in value.
•Venture capital firms. Ever wonder how young companies with no business histories or products get the money they need to start up? Launching a semiconductor or biotechnology firm can be expensive and beyond the credit card limit of any entrepreneur. That’s where venture capital, or VC, firms come in. These firms take money from institutional investors, like pension funds, and make relatively small investments in scores of small upstarts. Most of the investments will go down the drain as the firms implode and never make a dime. But if VC firms do their homework, they’ll more than make up for the losses with just a few home runs. VCs that bankroll the next Microsoft or Google will make tremendous returns on their investment despite the risk of funding other companies that fail.
