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Venture Capital vs. Hedge Funds: Similarities and Differences

In the stock markets, both are powerful influences. They both want to make money, but since their approaches to spending differ, they may compliment one another.

Due to the significant differences between venture capital and hedge funds compared to publicly traded equities, bonds, cash, or commodities, both are categorized as alternative asset classes. Despite operating in separate areas of the financial markets, hedge funds and venture capital employ identical legal and fee structures and are very loosely regulated by the government. 

Young, privately held businesses with promising development potential might get equity investment from venture capital (VC). Contrarily, hedge funds often invest in publicly traded assets such as stocks, bonds, and other financial products like derivatives. Hedge funds are characterized by their use of borrowed capital and propensity to make bets on and against assets, thus the name "hedged" and trade stock holdings in the company for the funding required for startups to expand. 

Their funding is mostly provided by organizations that act as limited partners, or LPs, in the specialized partnerships or funds that VCs administer, including pension funds, endowments, and foundations.

Additionally, VC companies often provide managerial, financial, and technical guidance to the entrepreneurs they fund and may have representation on their boards. There are close to 2,000 venture capital companies that manage their money via general partnerships, including well-known ones like Silver Lake, Sequoia Capital, and Kleiner Perkins.

These specialized partnerships typically have a lifespan of 7 to 10 years, during which time the money invested in them is essentially locked up in the fund and cannot be withdrawn.

When the startup is purchased by a larger, more established firm or when the business makes an initial public offering, or IPO, VC investors may benefit. Before each of these exits, the company and the LPs might sell some or all of their investments to another venture capital firm or institutional investor.

Several VC firms have seen enormous returns from their investments in successful companies like Apple, Intel, and Amazon. But the overwhelming majority of VC investors suffer significant losses. According to the National Venture Capital Association, between 25% and 30% of all VC investments are unsuccessful, while up to 40% merely give investors their initial investment back. The failure rate is estimated to be 75%.

However, returns have often outperformed the market. According to research company Cambridge Associates, over the 20 years that concluded on September 30, 2021, U.S. venture capital returns were 10.9% annually on average. That just exceeds the Standard & Poor's 500 Index's historical average yearly return of 10%.

How do hedge funds work?

Hedge funds are comparable to VC funds in terms of their legal and fee structures and are similarly primarily backed by institutional investors. Hedge funds, however, often invest in publicly traded securities, such as stocks, bonds, and futures.

There are more than 10,000 hedge funds in the United States, and they use a variety of methods. A strategy that almost all hedge funds use to some extent is short selling, which involves betting that the value of an asset will decrease. Typically, this entails renting a security in exchange for a fee, selling it, and then purchasing the same number of shares at a discounted price to reimburse the lender and lock in a profit.

One of the following four broad investing techniques best describes hedge funds:


These funds, which are also known as "equity hedges," may invest in PepsiCo stock while selling short Coca-Cola shares.

Relative worth:

Mispricings between linked instruments, such as bonds, which are often issued by a same business, are found by managers. For instance, a management may purchase 20-year General Motors bonds and sell short the company's 5-year bonds. As long as the 20-year bond gains more than its shorter-term equivalent, the hedge fund will probably earn a profit.


These place bets in advance of business changes including unexpected quarterly results, mergers, reorganizations, and dividend increases. They may hedge their optimistic bets on expected favorable developments by placing a short bet on an exchange traded fund, or ETF, that is targeted at their sector.

Worldwide Macro:

These gamble on global economic trends, particularly through investing in the sovereign bonds or currencies of other countries, generally in the futures markets. They are also known as macro funds. For instance, if oil prices decline, it may be appropriate to bet against the Norwegian kroner, which earns from higher oil prices, and invest in German government bonds, whose economy advantages from reduced energy costs.

Numerous more tactics fall under these main categories. In order to find patterns or price anomalies across hundreds of markets and try to benefit from them, frequently by the second, these computer-based algorithms utilize specialized short-selling, convertible arbitrage, and systematic quantitative.

Hedge fund managers often borrow money while investing in order to increase profits. Leverage, however, has a double-edged nature and may be fatal if markets turn sour. It may exaggerate profits.

For instance, in 1999, Long-Term Capital Management LP, a well-known global macro hedge fund, borrowed $50 for each dollar it invested. Its management team included Nobel Prize-winning economists. When its predictions for the bond market turned out to be inaccurate, it was unable to pay its commitments, and the fund failed, necessitating a major, government-planned Wall Street bailout.

According to Chicago-based Hedge Fund Research, which monitors the sector, during the 31 years from 1990 to 2021, the HFRI Institutional Fund Weighted Composite Index, which measures hundreds of hedge funds, returned 10.37% yearly on average. Only five of those years saw a loss for the HFRI Index, the worst year being 2008 when the index fell 19%, less than half the 37% loss experienced by the Standard & Poor's 500 Index.

Hedge funds against VC companies

VC companies and hedge funds are fundamentally different from one another in terms of their capital-raising, investing, and exit strategies.


Both venture capital and hedge fund companies rely heavily on organizations like foundations, endowments, pension funds, and high-net-worth individuals to generate money. However, given the lengthy lockup periods for their investments, VCs are more likely to interact personally with potential investors. In contrast, large hedge funds often use sales and marketing teams to generate money.


VCs make long-term investments. Hedge funds are focused on monthly, quarterly, and yearly returns and often trade on a second-by-second basis. It's important to note that some hedge funds with a focus on technology are increasingly experimenting with VC-style investments.


Each levies an annual management fee of 2% of the assets under management as well as a performance fee or "carried interest" equal to 20% of any earnings. "High water mark" fees are often included in hedge fund fees: A fund's net asset value must be higher than any value at the end of any prior calendar year before it may receive carried interest. Hedge fund managers are so extremely motivated to produce consistent profits year after year. Additionally, the carried interest may not always start accruing until profits have above a hurdle rate linked to a benchmark, such as the 30-year Treasury bond.


In order to decide if an entrepreneur is the next Steve Jobs, venture capitalists (VCs) frequently have a thorough understanding of the specific industry dynamics and the track record of a startup's executive team. Contrarily, hedge fund managers and their colleagues don't always need to go as deeply into any one particular startup but still need to have a comprehensive understanding of the multiple marketplaces in which they operate.

Sectoral Emphasis:

The technology and biotech industries are primarily targeted by the VC business. Although not all hedge funds are more diversified in their investment strategies. Both kinds of funds seek guidance from outside professionals, many of whom are retired top-level business leaders with extensive knowledge.


The ability of investors to leave is a significant distinction between venture capital and hedge funds. In order to access their invested funds, investors in VC funds often have to wait 7 to 10 years for the VC to wind down the fund. Contrarily, investors in hedge funds often have the option to withdraw their money on a monthly, quarterly, or yearly basis, but they may need to give the fund sufficient notice.